How to Know What Stocks to Buy, at Any Moment
By Dr. Steve Sjuggerud
August 13, 2008

I was such a fool.

All my friends were getting rich literally overnight... but I didn't join them.

It was 10 years ago. Just about every brilliant guy I knew left his "legitimate" job for a mountain of stock options at a dot-com startup in California.

Meanwhile, I was doing the polar opposite. I was living in Baltimore, writing an investment newsletter. "How quaint," I'd hear from these new zillionaires at reunions and Christmas parties. I was living my dream... but it didn't include a million-dollars worth of stock options and a perpetual tan.

They didn't know the "top" of the speculative tech bubble was in... that their jobs and stock options could disappear overnight. But looking back, there were two hallmark signs:

1) Returns in the preceding few years were ridiculously good.
2) And everyone wanted in, assuming you couldn't NOT get rich.

As an investor, business owner, or employee, please remember: When you see these two things, chances are you're darn close to a top.

For the specifics of the tech mania... According to the Dow Jones sector indexes, Technology was the best-performing sector in 1996, 1998, and 1999. It was up 36%, 70%, and 84%, respectively. (Many other indexes more specific to dot-coms did even better.) After the 84% return in 1999, everyone wanted in.

You know how it ended. My friends' stock options wound up worthless. The laws of nature hadn't been repealed. Over the next three years, tech stocks got clobbered. Take a look at the returns of the Technology sector:

Then came real estate in the mid-2000s...

I was a fool once again. This time, I was living on the east coast of Florida. Everyone around me was getting rich in real estate (on borrowed money). I was foolishly writing an investment letter, with no debt. "How quaint," I heard again in a condescending tone at cocktail parties.

The Dow Jones Real Estate index soared in the mid-2000s:

By mid-2005, the top was obviously near... Because again, 1) Returns in the preceding few years were ridiculously good, and 2) Everyone assumed you couldn't NOT get rich!

Just like tech, real estate busted.

Now it's late 2008. What's at risk? What's been hot in the preceding few years? Consider the Dow Jones Oil & Gas stock index:

Oil & Gas stocks performed better than real estate stocks did in their big run... They actually performed just as well as tech did a decade ago. Does this mean the top is in? It sure seems like it should be near. Returns have been ridiculously good... and people think you can't NOT get rich in oil now.

Let's take a look at what's happened... Wow! The Dow Jones Oil & Gas index is down 18% since June 30 of this year – that's like six weeks!

OK, so we know what NOT to buy... We DON'T want to buy things that have performed well over the last few years, when investors are getting giddy over the prospects for the future. This almost always means the assets are selling for ridiculously high prices, like tech stocks in 1999 and real estate in 2005.

So what should we buy? You guessed it... We want to buy exactly the opposite of these two things. We want to buy cheap, hated assets that everyone has ignored for years. This is where the great values are.

Consider biotech stocks... returns this entire decade have been unimpressive, really. The returns in the last two years on the Dow Jones Biotech stock index have been particularly dead:

We have just the opposite of oil and gas... we have, 1) Returns in the preceding few years have been particularly dead, and 2) Nobody is clamoring to get in.

Let's take a look at what's happened this year... Everyone wants oil stocks, and they're getting crushed. Nobody's talking biotech... and they're up over 20% so far!

To get rich in stocks, you can't do what everyone else is doing. Most folks pick their stocks and mutual funds by performance. They look for the best performers over the last few years and put their money there. That's a bad idea!

Stocks aren't like baseball players... You can't pick them based on their batting average over the last three years.

Instead of looking at what's done well over the last three-to-five years, you're better off looking at what's dramatically underperformed instead. When you're talking about the major sectors, they all come back around.

The First "Screaming Buy" of 2008 Biotech's Next Big Bull Market Starts Now

As a starting point to put this theory into practice... oil & gas stocks have been the big performers over the last few years, while tech stocks and biotech stocks have been dead money.

If this idea is right (and I believe it is), selling oil and gas stocks to buy tech stocks and biotech stocks is the right trade to make.

Good investing,

Editor's note: Steve Sjuggerud is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.

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WORRIED ABOUT GOLD? THEN READ THIS.

Readers have had a lot to say about our recommendation to buy gold... Most of it along the lines of, "Nice job, smartass... I bought gold, and now I'm down a hundred bucks an ounce!"

Yes... Anyone who has bought gold in the past few months has seen the value of their holdings decline. But our advice is to sit back and consider two "big pictures."

One big picture is fundamental: We don't see physical gold as a trading vehicle. We see it as the ultimate form of wealth insurance. Gold soars when everything slumps... so it's a great diversifier. We buy hold and hope we never have to use it or sell it.

The other big picture is the long uptrend in gold, presented below. This uptrend began in 2001. Over the next five years, gold trotted from $250 to $450. In 2005, gold exploded. It doubled in just over two years to reach $1,000 an ounce.

So... are we surprised to see a "shakeout" after such a big gain? No way. No asset goes to the moon without a few big declines to scare everyone. And as you can see, gold could fall even farther and still be in "bull mode."