I now realize that it is a waste of time explaining why the market is still bullish. That is because a bull market is the natural state of affairs which takes place the vast majority of the time.
So instead our focus should be on what it would take for the bear to come out of hibernation. That will be followed by a section predicting an end of the year target for the S&P 500. And finally, I highlight specific strategies that should lead to your future outperformance.
Let's get started!
Bear markets emerge for one of two reasons:
1) Recession looms on the horizon awakening the next bear
2) Valuations get stretched (Ex. The bear market that started in 2000)
There are no current whiffs of a recession in the air. In fact, most experts are looking for a step up in economic growth the rest of the year. That outlook would only become rosier if the Trump administration is successful in lowering taxes (especially corporate taxes).
Unfortunately history has many examples of the economy humming right along and then a recession jumps out of nowhere. So, we will all need to keep a watchful eye on the key indicators with ISM Manufacturing, ISM Services and employment being the best early warning signals.
More . . .
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Now let's address the other side of the coin...valuation. I know folks who point to a historical average PE of 15 in order to say that this market is getting stretched given the current forward looking PE of 17.4. However, there is much more to the story.
You have to remember that PE's in the latter stages of bull markets typically move higher than average given the confidence folks have in a positive outcome. So, a PE of 17-20 is quite common at this stage of the game.
Lastly, and most importantly, is the relationship stocks have with Treasury rates. In general, the earnings yield for stocks is just a little bit higher than the 10 year Treasury. So, let's do that math.
Earnings yield is the inverse of PE. By dividing the $140 in expected earnings for the S&P this coming year by the current index price produces an earnings yield of 5.7%. Whereas the 10 year Treasury is only providing a meager 2.2% yield for investors. Given this historical relationship, stocks are an outright steal versus their main investment competitor in bonds.
End of the Year S&P 500 Target
2500 to 2550 feels like the right range to end the year, which is only a few percentage points higher than our current perch. That is because the first half had no real pullback or correction. Rarely does a year go by without that in the mix. So, we should expect some downside action at some point in the second half before grinding our way to new record highs.
However, this target is based upon the assumption that a new tax plan will likely not be in effect this year. So, if that positive catalyst did come into play, then 2600+ is very doable this year.
Either way, there are decent gains ahead for the average investor. For those who want to do better than average, then consider the strategies below to outpace the market.
3 Ingredients to Outperform
The safe route to profits is now over. No more hiding out in utilities, REITs and consumer staples. And no more piling into overpriced FANG stocks with the assumption that they will always go up no matter how stratospheric their PEs. The recent tech wreck should be a reminder that party won't last forever.
Investors will need to dig a little deeper to find the best stocks to outperform. Beyond selecting stocks with top ratings (Zacks Rank, Style Scores and Industry Rank), you will also want to load up your portfolio with more of the ingredients listed below.
Ingredient #1: growth, Growth, GROWTH!
Investors have been too risk averse for too long. You have to appreciate that the economy is heating up and that means earnings growth is heating up...and that means investors should be willing to pay more for the companies with truly exceptional earnings growth.
Start with expected earnings growth above the norms. The minimum level is 10% per year...but better at 15%, 20% or more. On top of that seek companies that are beating earnings regularly and estimates are on the rise. Yes, the Zacks Rank is your best friend in that pursuit. So focus on Zacks Rank #1 and #2 growth stocks.
Ingredient #2: Go Small or Go Home
This one goes hand in hand with Ingredient #1 above. The Flight to Safety movement the past few years also meant outperformance for large cap stocks and those with large dividend yields.
Now those ultra-conservative names are played out and growth oriented small caps and mid caps are starting to win the day. This trend should continue given all the ground they need to make up from the past few years of underperformance.
Yes, these smaller stocks are generally riskier. That is why you should consider having more stocks in your portfolio, each with a smaller allocation. This form of diversification also helps mitigate risk so you can enjoy greater rewards.
Ingredient #3: Value
It never hurts to buy stocks at a discount to their peers. The problem is that most investors have a set of historical standards for what they believe equates to a value stock. I am referring to certain measures of PE or Book Value or PEG etc. that typically denote an undervalued security.
Unfortunately, after 8 years of a bull market you will discover that most every stock is above those levels. Thus, those looking for absolute value based on these historical measures will find no stocks in their basket. So, the key is to use relative value measures to squeeze out additional gains. That is where the Zacks Value Score comes into play.
For example, our "A" rated value stocks are in the top 20% in terms of the value criteria that have been proven to lead to outperformance. Combine that with "B" rated stocks and you will be focused on the top 40% of value stocks available. These stocks should make up the bulk of your portfolio. And yes, do strongly consider selling those with D or F ratings for this important criteria as they will prove to be a drag on your portfolio.
What To Do Next
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Steve Reitmeister has been with Zacks since 1999 and currently serves as the Executive Vice President in charge of Zacks.com and all of its leading products for individual investors. Today he offers access to Zacks portfolio services, including his own Reitmeister Trading Alert, and invites you to download 3 tech breakthrough Special Reports for investors.