Sticking With Stocks

9/27/2010


Some people are hard to satisfy.

Early last year, a subscriber called me, complaining that our recommended stocks were falling. Most of the stocks that had this caller upset were outperforming the S&P 500 Index, and the key to long-term outperformance is consistently beating the market regardless of its direction.

According to the Hulbert Financial Digest, a newsletter that rates investment newsletters, Dow Theory Forecasts generated a 204% return in the 15 years ended June, versus 130% for the S&P 500 Index. To earn that return, we mostly relied on our ability to select stocks that outperform the market. Of course, while outperforming during a bear market contributes to attractive long-term returns, it doesn’t feel like good news when equities founder.

The fact is, most stocks fall during broad-based market declines. The caller I mentioned above found all stock declines unacceptable, a short-sighted stance for investors who intend to grow their wealth over time. Nobody likes to see red in their portfolio, but maintaining exposure to stocks even during the tough times is crucial to long-term returns.

Switching to bonds or cash feels like a wise move when stocks are falling. But over time, stocks tend to outperform fixed-income securities. According to Morningstar data on the annual returns of stocks and fixed-income securities from 1926 through 2009, corporate or government bonds were the strongest performers in just 13 of the last 80 rolling five-year periods. Based on 20-year periods, bonds were the top performer only once.

We raise and lower our recommended cash position to reflect the primary trend and the opportunities available in individual stocks, but we never go to 100% cash. This strategy has served us well since 1946. So, while we intend to raise more cash if the Dow Industrials and Dow Transports break below the July lows, do not expect us to change our ways and go to 100% cash.

Moving in and out of the market in an all-or-nothing fashion puts a huge premium on precise timing. Also, making timing decisions becomes even more difficult with the performance anxiety that comes with always being fully invested or fully in cash. A few mistimed all-or-nothing moves can put a serious dent in long-term returns, and we expect stocks to outperform bonds and cash over the long haul. From 1926 through 2009, large-company stocks delivered an annualized total return of 9.8%, versus 5.9% for long-term corporate bonds.

In keeping with our goal of outperforming the market, our Screen of the Month for September looks for strong fundamentals, excellent growth potential, and a history of outperformance.

SCREEN OF THE MONTH
The five stocks below earn Quadrix® Overall scores of at least 80 and have outperformed the S&P 500 Index in 2008, 2009, and so far in 2010.
– Estimated EPS Growth –
Total
Return
Since
Jan. 1,
2008
Company (Price; Ticker)
Quadrix
Overall
Score *
Curr.
Year
(%)
Next
Year
(%)
Next
5 Yrs.
(Annual.)
(%)
Sector
CSX ($55; CSX)
92
35
15
11
20
Industrials
DirecTV
($41; DTV)
94
65
32
23
64
Cons.
Discretionary
IBM ($130: IBM)
86
13
9
11
20
Technology
Ross Stores
($54; ROST)
93
20
9
14
101
Cons.
Discretionary
TJX Companies
($43; TJX)
92
18
10
14
44
Cons.
Discretionary
* Quadrix scores are percentile ranks, with 100 the best.

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