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Getting Ready For The Next Leg Up

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With the market pulling back from their recent highs, now’s the time to start getting ready for the next leg up. After heady gains this year, the market was ripe for a pullback. And it seems like we’re finally getting it. For perspective though, we also got one back in mid-February through early March. Stocks had gotten off to a strong start, then suddenly turned around. Panic set in for some investors as they braced for more downside. Some sold. Others shorted. And some refused to buy this market for fear of it going lower. But then it didn’t. And since then (the last couple of weeks notwithstanding), all of the major indexes have powered on to new all-time highs. If you missed out on this latest rally due to disbelief, or fear, it’s not too late. Because after this pullback, it looks like there’s a lot more upside to go. Fear Not There was nothing ominous in the pullback we saw earlier in the year. It was just your normal, ordinary pullback. Every bull market has them. In fact, stocks usually pull back about -5% roughly 3-4 times per year. (A pullback is defined as a decline between -5% and -9.99%.) And that’s pretty much what we saw from the Dow which pulled back -4.57% during that time, and the S&P which pulled back by -5.75%. And stocks usually correct -10% on average about once a year. (A decline of -10% to -19.99% is called a correction.) That’s what the Nasdaq did back then with a correction of -12.04%. But these are the pauses that refresh before the next leg up. And from those March lows, the Dow then surged by more than 16%, the S&P by 22%, and the Nasdaq by 28%. Now the markets are at it again. From the recent highs, the Dow has pulled back by -3.6%, the S&P by -4.2%, and the Nasdaq by -5.8%. After shaking the tree, it will be exciting to see how high the market can go next time. While pullbacks are never fun when they’re happening, if you know these are commonplace moves, you can instead look at them as opportunities to buy rather than places to sell. New Highs Beget Higher Highs For some reason, people seem reluctant to buy stocks after making new highs. I suppose they may feel like they missed the move, or that now stocks have more room to fall. But statistically, this is just not true. For one, the S&P, for example, has made 60 new high this year alone. Can you imagine all of the money you would have left on the table if you were afraid to get into stocks making new highs? But second, and more importantly, studies have shown that stocks making new highs have a tendency of making even higher highs. In fact, using S&P price data going all the way back to the 1950’s, it shows that stocks typically go up in the subsequent six months following new all-time highs. This means that stocks making new highs aren’t at any greater risk of going down. Quite the contrary, there’s a higher probability of stocks going up even further!

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