It's December, Stay Ruthless

12/1/2014


Funny things can happen at the end of a calendar year, especially when you're having a good one. When your system is working and the stock market is melting higher, it's easy to get a bit complacent. It's easy to lose focus amid considerations of year-end returns and taxable gains.

Performance of our lists
Year
Focus
List
(%)
Buy
List
(%)
L-T Buy
List
(%)
S&P 500
Index
(%)
Since 2003 *
2.3
2.8
2.0
1.3
         
2014 *
24.6
22.9
21.3
11.8
2013
36.0
42.8
42.7
29.6
2012
14.2
16.0
15.8
13.4
2011
(4.8)
(9.1)
(4.2)
0.0
2010
19.5
12.7
10.3
12.8
2009
40.0
37.6
30.6
23.5
2008
(48.8)
(46.3)
(36.5)
(38.5)
2007
22.8
19.2
10.8
3.5
2006
12.9
16.9
9.7
13.6
2005
8.1
13.2
4.1
3.0
2004
17.5
22.4
9.0
9.0
2003
20.2
29.2
24.6
26.4
* As of Nov. 25.     Returns assume fully invested portfolios, excluding dividends and transaction costs.

We're not going to let that happen. We're going to work the approach that has led to this year's strong returns: (1) keeping nearly fully invested in line with the bullish primary trend and (2) ruthlessly limiting our Focus List and Buy List to our best 12-month ideas. Here's our bottom-line advice:

➤ Stay invested. Our buy lists have 91% to 97% in stocks, with the remainder in a short-term bond fund. The Dow Theory is squarely in the bullish camp based on the action of the Dow Industrials and Dow Transports, and broader indicators like the S&P 1500 advance-decline line reflect a fairly widespread advance. We'd like to see new highs in the Russell 2000 and S&P SmallCap 600 indexes, but the recent superior performance of small stocks is encouraging.

Valuations are expensive but not egregiously so; based on median trailing price/earnings ratios, the S&P 1500 and most of its 10 sectors trade at a 10% to 20% premium to 20-year norms. Relative to bond yields, earnings/price ratios suggest stocks are attractive versus historical norms.

➤ Stay granular. Many argue stock-picking is obsolete, as judged by this year's woeful performance of actively managed mutual funds relative to capitalization-weighted indexes like the S&P 500. Others argue it's pointless, since there are so few truly cheap stocks available.

Both arguments miss the point. You don't need to invest like a fund manager with a billion-dollar portfolio, partly because you don't need to worry about getting fired if you have a bad year. And you don't need to limit yourself to stocks with single-digit P/Es to be a value investor.

By constantly searching for attractively valued growers with superior fundamentals, we've outperformed the indexes with less volatility. In our view, growth-at-a-good-price standouts like Alaska Air ($56; ALK), Ameriprise Financial ($132; AMP), Apple ($118; AAPL), Jones Lang LaSalle ($143; JLL), and Lam Research ($81; LRCX) remain top picks for the year ahead.

➤ Stay calm — and alert. Gauges of investor sentiment suggest the environment is getting a bit frothy, with too much bullishness and too little fear. That does not mean the bull market is at an end, but it does increase the likelihood of a secondary correction. Anticipating such declines with precision is impossible, so consider how you might react to a bull-market correction. Typical one-third to two-thirds retracements of the rallies since mid-October would bring the Industrials to 16,680 to 17,250 and the Transports to 8,200 to 8,700.


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