Take A Little Risk
7/9/2012
The Dow Industrials and Dow Transports have rallied within 3% of this year's respective highs of 13,279.32 and 5,368.93. A move above those levels would represent a bullmarket reconfirmation, meaning the June 4 lows of 12,101.46 and 4,847.73 would no longer be significant under the Dow Theory.
Still, the June 4 lows will remain actionable unless both averages close above this year's highs, so subscribers should be prepared to move toward a lowerrisk posture. A shift toward defensive, lowvolatility stocks often makes sense in such situations. But investors have been migrating toward lowrisk stocks for more than a year, and many appear relatively expensive.
How expensive? Consider the table below, which shows valuation statistics based on our Relative Risk scores. Based on five measures of volatility, Relative Risk scores slot the more than 4,400 stocks in our Quadrix universe into five categories.
Lowrisk stocks, the onefifth of stocks with the least volatile returns, have an average trailing price/earnings ratio of 20 — above the norm of 18.5 since 1994. By comparison, Highrisk stocks have an average P/E of 17.2 — below the historical norm of 23.3. Highrisk stocks have traded at a lower P/E on only 7% of the monthends since 1994, while Lowrisk stocks have traded at a lower P/E on 81% of monthends.
Stocks with Relative Risk scores of Low and Below Average earn lowerthannormal Quadrix Value scores, while those with scores of High or Above Average earn higherthannormal Value scores. Stocks with Low and Below Average risk typically earn the best Value scores, but today they earn the worst.
Implications for investors
The lesson for investors is not to load up your portfolio with highrisk stocks. Rather, today's valuation numbers suggest defenseminded investors should not limit their portfolios to lowvolatility stocks. Maintaining a broadly diversified portfolio (and using biggerthannormal cash positions to limit risk) makes more sense.
Highrisk stocks earn the worst Overall Quadrix scores, on average, though they rank better than normal because of their atypically high Value scores. Stocks with Below Average Relative Risk scores earn the highest Overall scores, followed closely by those with Average risk. The Monitored List supplement included with this issue includes Relative Risk scores on all our stocks.
