Bullish sectors still in control

5/19/2008


The major averages have been choppy but remain near recent highs, with continued strength in the energy, industrials, materials, and technology sectors offsetting weakness among financial and health-care stocks. With the primary trend bullish, our cash position remains at 15% to 20%.

Narrow leadership
Market leadership remains centered in groups exposed to commodities and business spending. Groups exposed to credit risk and consumer spending continue to lag.

Improved share-price action from the lagging groups would be a big positive for the market outlook, but all sectors don’t need to advance together for a bull market to continue — or for you to make money. As you consider how much of your money you want in stocks, keep two points in mind:

First, don’t let others define “the market” for you. Unless you’re buying an index fund, bearish or bullish arguments based on capitalization-weighted indexes like the S&P 500 Index may not be particularly relevant.

Whether the S&P 500 Index is overvalued or undervalued is worth considering, but more important is your ability to assemble a diversified portfolio of attractively valued stocks. Similarly, while it’s worth noting that S&P 500 Index earnings have slumped three quarters in a row, we’re more interested in the generally solid profit reports of our recommendations.

Second, don’t worry about benchmark risk. How your portfolio correlates with the S&P 500 Index is irrelevant. What matters are your returns, and your risk of losing money. We try to control risk by limiting exposure to any single sector. But we don’t worry about our exposure relative to the S&P 500 or any benchmark.

Partly because so many stocks in energy and technology are surfacing in our search for new buys — and partly because we are already heavily exposed to these sectors — we have kept cash at 15% to 20% of our Buy and Long-Term Buy List to limit risk. As opportunities develop in individual stocks, we hope to reduce our cash position.

Conclusion
Recent measures of the broad market, including advance-decline lines and the Value Line Arithmetic Average, have shown some improvement. Continued strength in such measures would be bullish. But, even without a broadening in the market’s leadership, subscribers should not be afraid to own such reasonably valued leaders as IBM ($127; NYSE: IBM) and Qualcomm ($45; NASDAQ: QCOM).


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