What To Buy When Stocks Aren't Cheap With Its Way Higher Without Any Significant Correction

It hasn’t exactly been a conventional year though. It might seem fitting that the tech sector has helped pace the S&P given the big rallies enjoyed by the likes of Facebook (up 42%) and Apple (up 26%)but it’s been somewhat more of a surprise to see the typically-defensive utilities and health care sectors joining tech in the top three.

Health care has enjoyed a bounce from biotech - which recently surged back to fresh highs after stumbling for months — but in the utility space the driving factor has been the continued pressure on Treasury yields. The bond market has been a winner in 2014, keeping yields low even as many expect the Federal Reserve to raise its benchmark rate sometime in 2015.

All year, any hint of a broad market retreat has been snuffed out fairly quickly. “Investors have been conditioned to buy the dip,” says BlackRock chief investment strategist Russ Koesterich. “Part of the reason it’s worked for several years is the belief that if there is a shock, the Fed will step in to make it all better.” If investors start to think bad news is more than just a precursor to Fed aid, volatility could kick up, Koesterich says, which doesn’t mean investors should look for assets with what he calls “a valuation cushion,” where the good news isn’t already fully baked into its price.
Buying the dip without overpaying is a delicate balancing act, but Koesterich likes some cheap emerging markets, even Brazil and India, which have rallied recently, and the more cyclical sectors in the U.S. with more operating leverage to the economy like technology and energy companies.

James Abate of New York City’s Centre Asset Management also remains fairly upbeat on the market, though he sees warning signs.
“The biggest risk we see is sentiment around profit margins,” he says, pointing out current estimates are counting on nearly 90% of the S&P 500 to record higher profit margins in 2015.

Fort Pitt Capital Group’s Kim Forrest, who helps manage the Pittsburgh-based firm’s $1.4 billion under management, says she has a lengthy list of stocks she would love to buy, in the technology sector particularly, but that prices feel too high. “It feels like they just march up relentlessly,” she says. “There’s no one area of the market that’s uniformly cheap with low expectations, just screaming ‘Buy Me,’” Abate says. He’s looking for companies that fulfill certain criteria, like the potential for incremental margin expansion, better return on assets than peers and cap-ex discipline.

“The really cheap stuff has a lot of hair on it,” says Chris Bertelsen, who helps oversee $4 billion at Sarasota’s Global Financial Private Capital. “I don’t want to buy an Aeropostale where I don’t know if it will be around in a year.” Bertelsen, who has enjoyed gains over the last two years in old-tech names like Hewlett-Packard, Micron Technology and Intel INTC, has moved into some “new tech” names this year. “Remember when high-multiple stocks got slaughtered earlier this year? We used that to buy names like Yelp and TripAdvisor, and some Twitter in our more aggressive portfolios,” says Bertelsen.