How To Play The Bull Market
The market's primary trend is not in question. With the Dow Industrials at their highest level since 2007 and the Dow Transports at all-time highs, the Dow Theory is squarely in the bullish camp. Broader market indexes are at multiyear or all-time highs, and advancing stocks have outnumbered declining stocks by a wide margin in the rally since mid-November.
The question, in our view, is how you should play the bull market. Should you: (a) deploy your remaining cash reserves; (b) let the opportunities available in individual stocks determine whether you are fully or nearly fully invested; or (c) look for a pullback since the market has come so far so fast?
Our answer is all of the above: We're taking our Buy List's stock-market exposure to 96.8% because we want to add J.P. Morgan Chase ($47; JPM), but we're worried about a secondary correction and intend to dispose quickly of stocks we no longer view as top picks. Our Long-Term Buy List has 91.2% in stocks. Our posture, as usual, mostly reflects four considerations:
• The Dow Theory is not much help in timing secondary corrections, but it does provide some guidance on their potential magnitude. A typical one-third to two-thirds retracement of the rally since mid-November would put the Industrials at 13,500 to 13,000 and the Transports at 5,550 to 5,220.
• Valuations suggest stocks are neither particularly cheap nor particularly expensive, with the median stock in the S&P 500 Index trading at a 6% discount to 18-year norms based on trailing P/E ratio. Small and midcap stocks trade at slight premiums to long-term norms.
• Sentiment numbers suggest investors have become a bit exuberant, with surveys of individual investors revealing a jump in the percentage of bulls. Likewise, inflows into mutual funds and exchange-traded funds have surged in 2013. Bullishness among investment newsletters has also jumped, with the percentage of bulls now exceeding the percentage of bears by more than 30% — historically a sign of excessive optimism, according to Investors Intelligence.
• Our Intermediate potential risk indicator, based on the percentage of New York Stock Exchange stocks trading above their 200-day moving averages, has jumped to 82% — higher than 92% of the daily observations since January 1989. Historically, a reading above 70% has indicated a higher-than-normal risk of a secondary correction.
A near-term correction is possible, but we expect stocks to move higher this year and are maintaining a mostly invested posture. Magna International ($53; MGA) offers a top pick for new buying.