Usually, near the end of bull markets, fewer and fewer stocks continue to perform well while the average stock languishes. Many times those "hot" stocks are investor favorites with huge multiples and good long term prospects. This appears to be what is happening now. The S & P 500 had an excellent gain last week but the average stock barely advanced at all and many declined. This is not a healthy situation and is another cautionary development for stocks. Earnings estimates also are slowly fading and the longer term trend could change from bullish to neutral at any time. Valuation remains terrible and sentiment is still neutral but definitely reversed last week. I continue to hold a net 30% long position and that allocation is very unlikely to increase any time soon.
Volatility and weakness in the broad market has caused some consternation among investors and my sentiment indicators have improved as a result. They are still some distance from being truly bullish, though. On the negative side, valuation remains terrible. More importantly, earnings estimates are being reduced, raising the possibility that the current uptrend in forward estimates will turn negative in the next few weeks. Should that happen, my model will go to a zero exposure until earnings prospects improve. For now, the neutral sentiment factor is enough for me to continue with a 30% equity exposure.
My model has only been invested at a net 30% level for six weeks during the first half of this year. This week will be the seventh. The Greek vote will probably lead to some weakness on Monday but, ultimately, it is all about earnings and the estimated earnings trend over the next 52 weeks is still positive. Valuation remains terrible and that fact will probably hold any exposure to the 30% level unless stock prices decline meaningfully. Sentiment factors, though, have improved and are now neutral. Small investors and speculators have become somewhat unnerved by the financial condition of various countries in the world. They will get downright scared if the markets get hit hard. That would prompt a more aggressive stance on my part.
Richard Moore, CFA
With my wife in Hawaii