Calling stock market tops is a fool's errand. The simple fact is that people will continue to try to do it in order to shake some weak hands free of the stock they hold. Don't get me wrong, I love taking gains, but right now is not the time to do so. The prudent investor has a game plan for what is to come and I want to share my plan with you. It is based on a lot of empirical evidence that supports higher stock prices, but we have to remain disciplined!
The basic idea here is that we have to be accepting of more market risk. This seems contrary to public opinion as you undoubtedly have heard many calls about valuation, accelerating risks and of course the market making a top. All of these are just plain wrong and it only takes a glance at a long term chart to tell you why.
The market has continued to move higher, crushing the shorts and making investors wish they were fully invested already! Just look at a five year or ten year or even a twenty year chart! There have been some setbacks, but we are moving higher unless there is a giant bearish catalyst lurking out there that few if any see.
Data On Our Side
One of the key reasons I think we continue to move higher is because we have some excellent data behind us. This data isn't the only reason stocks move higher, but it shows us that we are not alone in thinking that more good times are ahead.
Continued . . .
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The first data point is probably the most important. The employment picture is a good one right now, with the economy continuing to add more jobs as more people rejoin the workforce. It used to be said that 3.5% - 4% unemployment would be considered full employment, but we are much more entrepreneurial now so we could probably bump that range up to 4.5% - 5%. Right now, we are at 4.3% unemployment.
The next data point is almost as important and is really the foundation of my bullish stance. The CB Consumer Confidence reading that was reported on June 27 topped expectations again and it shows that consumers will continue to do what they do best ... CONSUME! This data point gives me confidence that this bull market will continue to roll higher.
Finally, as far as data points go, I want to speak about home sales. The general trend has been higher, and that goes for new home sales as much as existing home sales. Generally speaking, most of these sales are going for ever higher prices. And due to the fact that they are often the largest investments people tend to make, there is going to be excess capital available for investment. When sale prices start to materially fall, that could be a time to pull in the reins.
How To Be Positioned
Now that we are on the same page about where the market is headed, let's adjust our risk reward ratio. The market will reward those investors that take an appropriate amount of risk... and the more sensible the risk, the greater the reward.
This is not to say you can take out a shotgun and fire away at whatever moves and expect to bag dinner. You have to learn to point it at the right "herd" of stocks. Right now, I would be pointing my weapon of choice at a herd of low priced stocks. Low priced stocks come with inherently more risk, but in a risk-on market they offer outsized potential returns.
For the foreseeable future, low priced stocks will offer much greater rewards for similarly priced risk. So this segment of the market could drive outsized gains for your portfolio. The problem is, which low priced stocks do you look for?
"Risk On" Markets Love Growth
The instant a company shows big growth, it is on my radar screen. I love growth stocks because I am a firm believer that expenses have to head to 'zero' if there is no revenue growth. That isn't a reasonable scenario, so if you are not growing on top, don't expect to be on my hit list.
The fastest way to higher earnings is by selling more goods or services. If one holds margins constant, then an increase on top will flow directly to the bottom line and then you have growth on top and on bottom.
That same growth is what the risk-on market craves. My experience tells me that low priced stocks that are seeing growth on top are much better picks than the ones that are "bottoming out." I try to avoid those turnaround stories; I want to see progress in the form of topline growth in my turnarounds.
Narrowing It To Just A Few
We have already come a long way. We have come to the realization that this top is just like tops before it and it too will be topped by an even 'toppier'-looking top. The data is on our side for more growth and higher asset prices and, almost as importantly, the consumer has our back.
We know that the best place to be is in the land of low priced stocks as they offer the best risk reward ratio in a market that is clearly Risk On. More than that, the Risk On market loves stocks that are showing growth. So what is the final piece to the puzzle?
Given that you adhere to the above, the thing that sets a select few apart from the others is earnings growth. It seems obvious, but there is a preferred method to employing this idea. Go for the earnings growth that is there before the report, which is another way of saying pay close attention to the earnings estimate revisions.
The easiest way to select the best low priced stocks is to follow the Zacks Rank. I'll help you select the ones with the right level of positive earnings estimate revisions.
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Brian Bolan is our Aggressive Growth expert and the editor of the Zacks Stocks Under $10 portfolio.