2017 Outlook For Stock

12/19/2016


Year-end is as good a time as any to step back and look at the big picture, and now seems like an especially good time to ask how much stock-market exposure you want in your portfolio.

Your answer will depend on your individual circumstances, including your return requirements, risk tolerance, age, and liquidity needs. Only you can determine your optimal allocation, but we think everybody should keep a couple of things in mind as we head into 2017.

First, partly because stocks are volatile, they have provided the best long-term returns. From 1926 through 2015, U.S. large stocks returned 10.0% annually, versus 6.0% for long-term government bonds. Annual returns for stocks were more than twice as volatile as those of bonds, though both stocks and bonds delivered negative returns in 27% of the calendar years.

Second, the main point of investing is to amass enough money to fund your desired spending. If you can sell now and fund all your likely spending, you should consider cashing out — especially if a 20% to 40% bear market would mean you are no longer set.

Once you determine your long-term allocation to stocks, you can use our recommended stock-market exposure to fine-tune your portfolio. For example, if your long-term allocation calls for 50% in stocks, our current advice would mean 94.3% to 94.4% of that half of your portfolio would be in stocks.

Set your long-term allocation at a level you can tolerate through the market's ups and downs, knowing that we will attempt to sidestep bear markets but will seldom have less than 60% of our buy lists in stocks. In setting our exposure, we focus on four primary indicators.

The primary trend. The Dow Theory was confirmed as bullish on Oct. 5, when the Dow Transports surpassed their April closing high of 8,109.19. The primary trend is viewed as bullish when both the Dow Industrials and Dow Transports reach significant highs, which may or may not be all-time highs. Still, this month's move to all-time highs in the Transports removed any doubt regarding the primary trend.

While the bullish primary trend does not preclude the potential for a market correction, it does suggest investors should view a pullback as a buying opportunity. From current levels, a typical one-third to two-thirds retracement of the advance since the June 27 low would bring the Industrials to a range of 18,067 to 18,994. For the Transports, the equivalent range is 7,869 to 8,645.

With pullbacks into those ranges, it will be crucial that both averages rebound fully and reach fresh highs.

The market's valuation. As measured by median price/earnings ratio, stocks in the S&P 500 Index are pricier than more than 80% of month-ends over the past 20 years. Using the same gauge, the S&P MidCap 400 and S&P SmallCap 600 indexes are more expensive than at least 95% of month-ends since 1996.

The trailing P/E of the S&P 500 Index is nearly 25, versus 21 since 1980 and 18 since 1950. Relative to historical norms, the spread between earnings yields (earnings/price ratios) and bond yields still favors stocks. But the advantage has narrowed considerably since July, reflecting higher stock prices and bond yields.

At 1.6%, the gap between the S&P 500 Index's earnings yield (4.1%) and the 10-year Treasury yield (2.5%) is higher than the norms of -0.5% since 1980 and 1.0% since 1950. All else equal, if Treasury yields rise to 3.1%, stocks will no longer be cheap versus bonds compared to the norm since 1950.

Investor sentiment. The percentage of bullish investment newsletters has surged to its highest level in more than two years, according to Investors Intelligence. Individuals are also unusually bullish, according to surveys from the American Association of Individual Investors.

The availability of attractive stocks. In the first half of 2016, the reasonably valued growers favored by Quadrix underperformed by a wide margin. While such stocks have played catch-up since June 30, they remain comparatively attractive based on valuations. Encouragingly, top stocks based on Quadrix Overall score have outperformed in four of the past five months.

Conclusion

The primary trend is unambiguously bullish. But stocks seem expensive, especially if the Federal Reserve follows through on plans to raise rates at a faster-than-expected pace in 2017. Sentiment is unusually bullish, though not quite at extreme levels. Some quality growers are still available at reasonable valuations, though many of the most attractive names have cyclical exposure.

Subscribers should maintain a bullish posture heading into 2017, and our buy lists have 94.3% to 94.4% in stocks. But the market's upside will be dependent to a large extent on the revival in corporate earnings growth, so we'll be following fourth-quarter profit reports carefully.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com