Author: Richard Moore
Covestor model: Market Comparables
Being overly cautious — at least in hindsight– led to another month of performance that was worse than the major market averages in March. However, I have developed a model for exposure to the market and I continue to follow that model (See the “Charts” page on my website, theastuteinvestor.com).
It seems to me that the market in 2012 is developing much like the market in 2011. Small investors and speculators have chased the market higher during the early part of the year in an attempt to put money to work and earn more than the paltry returns being offered by short-term low risk fixed income instruments. The market was hit hard during the middle part of the year, but earnings continued to grow and the market was able to recover and post a small gain by year’s end.
This year, I believe similar market action could occur, although earnings seem much more problematic. So the possibility of subpar market results are possible.
My model uses four factors to gauge stock market risk and potential:
- 1) Sentiment: Small investors and speculators are by some measures the most bullish they have been in at last the past nine years — which by nature is a contrarian signal, and bearish.
- 2) Earnings estimates: This is the most bullish of the factors I watch. However, estimates now are almost 19% higher than the last twelve months’ earnings. I question the ability of these companies to report those kinds of results given the problems in Europe and the already high levels of corporate margins. First-quarter results are to be reported soon and should be watched closely.
- 3) Valuation: It’s a little bit on the high side given the stock market increase over the past several months.
- 4) Technical factors: They are still bullish are still bullish because the market is trending higher.
These factors, when combined, currently lead me to only a 10% exposure to the stock market.
I am using the S&P 500 ETF (SPY), since my desired exposure is too small to allow me to diversify with individual issues. I am also currently attempting to use Dow Jones Industrial stocks and the inverse Dow Jones ETF (DOG) as a cash substitute with 25% of my portfolio.
I am long five stocks that my screening system says can outperform the overall Dow Average in good or bad markets as I attempt to achieve a 2-3% annual return with this approach for this part of the portfolio.
