Where to Find Value in an Overbought Market

What Stocks to Buy in an Overbought MarketMany smaller companies are now reporting their financial results, and very soon, it will be the lull between earnings seasons, when the only fuel the marketplace has to go on is monetary policy and economic news.

It wouldn’t surprise me at all if stocks took a break for the entire second quarter. Fourth-quarter financial results were decent, but they weren’t the kind of numbers that justify loading up on positions. Stocks seem to be about fully priced and there’s no real reason why they should go up near-term, especially considering last year’s performance.

The market had a tough time at the very beginning of the year but recovered strongly after the Federal Reserve provided certainty on monetary policy and the outlook for quantitative easing. There were some material corporate events in terms of new share buyback programs and select dividend increases, but most companies announce dividend news in the bottom half of the year; this is when we might see stocks generate further capital gains, if any.

Last year’s performance on the stock market was just so exceptional that stocks will be doing well if they close flat for this year.

Turning to blue chips for their corporate outlooks always yields useful information, even if an investor is not interested in the company’s shares. A lot of blue-chip stocks reported, in their fourth-quarter financial reports, that they expect high-single-digit sales growth in 2014 and high-single- to low-double-digit growth in earnings. This is pretty solid for mature, slow-growth enterprises, and it helps validate the market’s recent run as earnings per share catch up to share prices.

But if an investor was considering creating a new portfolio of stocks right now, there isn’t a lot of value around; it’s challenging to be a buyer in a market that recently did so well to the upside.

Blue chips that are selling off represent opportunity, but those that are still trading right close to their all-time record highs don’t seem worth buying currently. While the interest rate cycle is going to change, this year, the outlook still favors dividend paying stocks, and I think yield plays represent the best bang for your buck in this market, especially given comparable investment risk.

In this market, there’s no rush to take action, especially if an investor is looking to put together a new long-term retirement portfolio. (See “Pullback in Stock Prices Makes These Dividend Payers Attractive Again.”) Stocks went up tremendously last year in what I view as a breakout of the previous long-run trend. Because the breakout was so pronounced and on the heels of rising share prices for several years before, value is not currently prevalent.

Therefore, it’s a great time to identify strong companies and follow them for their corporate results and for an attractive entry point.

In a slow-growth world, rising dividends are a very attractive attribute. Currently, there is value to be had in domestic energy investments. Real estate investment trusts (REITs) are vulnerable to pressure on interest rates and investment risk with financials, which are due for a new cycle, is still high.

At the end of the day, there’s no need to chase anything in this stock market. A material price correction in stocks is still way overdue.