Tales of a Technician: The Seed Sower | Tackle Trading: The #1 rated trading education platform

Tales of a Technician: The Seed Sower

seed sower

The cyclical nature of markets makes seasonal analogies quite apt. Stocks travel through their own versions of Spring, Summer, Fall, and Winter. Instead of adopting the usual four season model, however, we’re going to simplify even further.

Planting season is when we sow seeds for eventual harvest.

Harvesting season is when we, well, harvest our sowed seeds.

For asset accumulators, bear markets should be viewed as planting season. These rare seasons, while volatile, provide the optimal environment for planting. Rich soil provides potent conditions for your plants to grow tall.

And what exactly is rich soil?

Cheaper Valuations

More on that in a minute. But first, consider the approach of a long-term investor who invests bi-monthly into stocks through a 401(k) or some equivalent account. Are they not seed sowers? With every paycheck, they toss their greenbacks into the financial markets in hopes that with time they will grow into a seven-figure tree. For them, planting season lasts for decades, indeed, their entire working career. The harvest comes during retirement where they look to reap the rewards finally.

For an investor such as this, each dollar invested in bear markets has the power to grow taller than those deposited during bull markets. If they ventured outside the world of automatic investment and into that of tactical timing, I would encourage them to increase the amount of their deposits during bear markets (like now).

Back to cheaper valuations.

Fire sales in the stock market provide the richest soil to plant in. Feast your eyes on the following graphic for a spell:

entry points

The first column shows the price to earnings ratio for the S&P 500. Every other column shows the subsequent return you would have realized if you invested in the S&P 500 when it’s P/E ratio sat at each respective level. The takeaway is simple, logical, and perhaps obvious:

Investing at lower valuations rewards higher future returns.

And, of course, the inverse is also true: investing at higher valuations rewards lower future returns. That means lower valuations are desirable for any who possess seeds to sow. And do you know what creates such attractive discounts?

Bear Markets

Consider lower valuations the silver lining of a bear market. These volatility-riddled episodes reset the market to a more satisfying starting point for the seed sowers among us. Heading into 2019 here’s how far the major indexes have fallen from their peaks:

Nasdaq: – 19.5%
S&P 500: – 16.3%
Russell 2000: – 24%

As a result of the bloodletting, market valuations have cheapened considerably. Let’s get an updated view of the trailing 12-month P/E ratio of the S&P 500.

trailing P E ratio

With the recent descent, it now lies at 17, down from 24. With the P/E back to 2014/2015 levels, it’s also beneath both the 5-year and 10-year average.

Does this mean investors should feel better about putting money to work now versus six months ago? Undoubtedly!

Does it mean valuations won’t get cheaper? Nope!

Maybe this bear market goes the distance and we tumble through 2019 morphing the now 16% drop in the S&P 500 to a -30% thrashing. Said destruction would drag the P/E down toward 12 or so.

Fortunately, there are a few ways we can be strategic about capitalizing on the stock sale. I’ll dive into one such idea next time.

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