Follow The Money

5/26/2014


Making a prediction and being proved right can be quite satisfying. But psychic satisfaction doesn't pay the bills, and your goal as an investor is to make money — not prove how smart you are.

As an individual investor, anonymity is among your biggest advantages. Nobody is tracking your quarterly returns, and nobody is second-guessing the rationale behind your decisions.

In other words, you don't need to pretend you can see the future better than most people. What you need is a system, a way to keep the odds in your favor by adjusting your portfolio based on observable market conditions. For our money, equity exposure hinges on the following:

The primary trend. With the Dow Industrials and Dow Transports reaching all-time closing highs this month, the primary trend is unambiguously bullish under the Dow Theory.

The market's valuation. When stocks are clearly expensive, the risk of a market top is elevated. Based on expected current-year earnings, the median P/E ratios for the large-company S&P 500, S&P MidCap 400, and S&P SmallCap 600 indexes are each 5% to 10% above 10-year norms — not great, but not wildly overvalued given today's low inflation and interest rates.

Investor sentiment. Unusually high optimism on the part of investors can signal that stocks are vulnerable to a reality check. Today's sentiment picture is mixed, with investment newsletters unusually bullish and hedge funds and other institutional investors becoming more defensive. Surveys of individuals reveal greater-than-normal caution, but solid fund inflows argue otherwise.

The opportunities available in individual stocks. As shown in Growth Focus, finding fast-growing companies at attractive valuations has become more difficult. But our Quadrix rating system is working nicely in this environment, partly because it identifies stocks with above-average growth rates and below-average valuations.

Conclusion

The weight of the evidence favors higher stock prices. Our buy lists have 93% to 98% in stocks.


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