Unfortunately I'm already fully invested in stocks, so this is of more interest to those investors who may be thinking about when to reallocate some of their investment portfolio into the stock market. My view is that over the long term the stock market has shown a remarkably consistent trend, as shown in the logarithmic chart of the monthly closing value of the Australian stock markets "All Ordinaries" Index since 1980. Therefore, when "Mr Market" has gone beserk and the market is well above or below the trend is the best time to think about adjusting you portfolio (or rebalancing back to your target allocation).
I've highlighted where the market has temporarily deviated well above the long-term trend (in red), and where it has dropped well below the long-term trend (in green). These, to my mind, represent overbought (mania) and oversold (panic) conditions in the market, and would have been good times to reduce or increase your asset allocation to stocks.
The fact that during 2007 the stock market was in the "red zone" was why I bought some Index Put Options (since I didn't want to sell off some of my stock holdings due to capital gains tax concerns). It's also why I'm kicking myself that I let these options expire in Dec 2007 without making a serious attempt at replacing them with a new series. Being in the "red zone" meant that the chances of a significant market correction or bear market were higher than normal, although the market wasn't as obviously overheated as was the case in 1987.
Today the All Ords is about 25% below it's all time high of 6,873 and has dropped well into the "green zone". To me this suggests the start of a buying opportunity (if I had any spare cash to invest). Of course, there's nothing to say the market won't drop even further before bottoming out - in 1987 the "crash" involved a drop of 36% in the All Ordinaries index. However, since the market wasn't as overvalued in 2007 as it had become in 1987, and the Australian economy is still benefiting from the commodities boom, I don't expect the market to drop much further (then again, this could just be wishful thinking on my part).
Copyright Enough Wealth 2007