It was a beautiful hot summer day, until a hail of pumice stones and ashes spoiled the magnificent scenery. Despite obvious warnings, nearly 5,000 people died on the 24th of August 79 A.D., the day Mount Vesuvius erupted.

Warnings – sometimes they go unnoticed, other times they are simply ignored.

For decades, investors have been conditioned that buy-and hold investing is the most efficient way to accumulate money. “Focus on the long-term picture and don’t sweat the small stuff” has been the (unsuccessful) motto for many. But, what if the long-term picture looks even worse than the short-term outlook? Then would it be time to change your approach?

One thing we know for sure is that the complacent attitude linked to buy-and hold investing has cost investors 30% over the past 10 years. That’s right. $10,000 invested in the S&P 500 (NYSEArca: SPY) 10 years ago is only worth $ 7,100 today. Buy-and hold not only lost 30%, it also cost you 10 years worth of potential savings.

To avoid another “lost decade” it is crucial to know whether another market meltdown is possible, or even likely. This article will get you up to speed on where the market’s headed and how to position your portfolio correctly. Quite possibly, this may be the best five minutes you’ll ever spend on investment research.

Short-term outlook: Trouble ahead

A look at the chart below reveals that the advance from the March lows has been choppy and without real rhyme or reason. The weeks leading up to the June 11th recovery highs were marked by low volume, a true tell-tale sign that conviction is lacking.

On June 15th, the S&P 500 (SNP: ^GSPC) broke the support line established by a 97 day rally, for the first time since the beginning of the rally. This break of momentum was confirmed by the Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC). The first breach of a multi-month support line indicated that the ensuing correction will be deeper than the prior, shallow pullbacks.

Already on June 11th, the day on which the stock market reached new recovery highs (on a closing basis), the ETF Profit Strategy Newsletter advised the following: “Conservative investors and those wanting to limit frustration, should use the current levels to raise cash and wait for the next big profit opportunity.”

Where is the next big profit opportunity? We will address this question in a moment. For right now, investors should focus on what should be the No.1 priority; protecting your buying power and keeping your money safe.

At current prices, investors get a chance to unload stocks, funds, and ETFs at prices most would have signed off on just a few months ago. Wouldn't you have jumped on board if someone told you back in March that you could sell your financial stocks for twice the price if you justed waited a bit? (See below what the ETF Profit Strategy Newsletter adviced to do early in March(. 

The Financial Select Sector SPDRs (NYSEArca: XLF), iShares DJ US Financial Sector ETFs (NYSEArca: IYF), and others, doubled since their March lows. The Dow Diamonds (NYSEArca: DIA) and Nasdaq QQQs (Nasdaq: QQQQ) gained as much as 40%.

Is now the time to be greedy?

Cash – Not so bad after all

If you are afraid of losing out on future gains and hesitant to move in cash, consider the following: Over the past ten years, cash has outperformed equities by 30%. Even during a low-interest environment, the value of cash has actually gone up.  Now you are now able to buy everything from stocks to electronics, at a steep discount.

If you are concerned that this trend will stop at exactly the same time you move your money from stocks into cash, take a moment to review the most recent consumer price numbers from the Department of Labor.

Consumer prices rose only 0.1% last month, posting the steepest annual drop in 59 years. Food prices, including all six of the major grocery food groups, fell for the fourth month in a row. Wholesale prices dropped 5% over the past 12 months, the largest annual drop in nearly 60 years.

The government’s effort to re-inflate the economy over the past few years, have failed miserably. The first and second bailout, were greeted with stock market declines of 20% and more. Most of the toxic real estate assets are dollar denominated, which means that wealth is destroyed faster than even the US government can print money.

Long-term outlook: Trouble ahead

How fast things can change. At the turn of the year, banks were begging the government for money. After 100% gains in the SPDR KBW Bank ETF (NYSEArca: KBE), SPDR KBW Regional Bank ETF (NYSEArca: KRE), and SPDR KBW Insurance ETF (NYSEArca: KIE), bank executives are feeling lucky and can’t wait to pay back their TARP funds to escape inconvenient salary/bonus caps.

Other publicly traded companies and even investors, have jumped on the rally bandwagon as well. According to Trimtabs Investment Research, companies issued $64 billion of new shares in the Month of May. This is the highest level on record.

In the March 2nd Trend Change Alert, the ETF Profit Strategy predicted the following concerning the prospects of this rally (just four days before it started) and the change in sentiment: “A multi-month rally, the biggest rally since the October 2007 all-time highs, should lift the indexes by some 30-40%. The UltraFinancial ProShares (NYSEArca: UYG) could morph into one of the best performing ETFs over the next few months.” UYG gained as much as 245%.

The increasing optimism would be a sign that the rally is running out of steam, the newsletter said. “The down trend will resume once the rally exhausts itself. This point of exhaustion is likely to happen at a point where optimism takes over and investors think that the Q1 2009 lows are here to stay.”

Investor sentiment is an outstanding contrarian indicator and can be applied to a short and long-term forecast.

Mutual fund managers are the epitome of community sentiment and crowd behavior. Ironically, fund managers are considered the Pro's. Mutual fund managers were blind-sided by the stock market's trend reversal in 2007. Fund managers were invested to the max when the stock market topped.

The percentage of cash held by mutual funds reached an all-time low of 3.4%, simultaneous to the market's all-time high. The up to 54% drop in the market has done little to extinguish fund managers' optimism. Currently, mutual funds hold about 5% of their assets in cash. At prior historic market bottoms, cash levels soared to above 10%. In fact, no major market bottom has been reached unless cash levels clocked in at record high levels.

Additional indicators with a track record of accuracy allow savvy analysts to pinpoint a target range for the ultimate market bottom. How so?

Historically, the stock market never bottoms unless certain indicators reach certain levels; just as ice doesn’t melt unless the temperature rises above 32 degrees. In order to reach those “trigger levels,” stocks will have to continue their downtrend.

The March and June issue of the ETF Profit Strategy Newsletter included a detailed analysis of a composite of four indicators, the “Four Horsemen”.  These issues also included a target range for the ultimate market bottom and corresponding ETF profit strategies for each of the market’s moves, and decoy moves.

Unlike our Mount Vesuvius predecessors, will we heed the warning signs?