NEW YORK (CNN/Money) -
Yahoo's spectacular earnings report after the close on Wednesday sent stocks soaring Thursday morning -- especially small growth issues. But by afternoon, the Yahoo enthusiasm had dissipated and stocks started pulling back.
The Nasdaq ended the day with a tiny three-point gain, while the Dow posted a 38-point loss.
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This vignette pretty much sums up current market sentiment. Expectations are high for small growth stocks -- anxiety is even higher. Even when hot stocks exceed their targets, they have trouble holding onto gains.
There are several questions here that are worth looking at. For starters, is the stock market really overbought? In other words, are investors' expectations unreasonably high, and are share prices due for a correction as a result?
If you consider the question only on a short-term basis, it may well be that sentiment has been too bullish. That would argue for the possibility of a further market correction.
But in the context of long-term economic fundamentals, it's hard to believe that the bull market could be over. Employment gains in March were the highest in four years, and first-time unemployment claims fell to the lowest level since President Bush took office.
Moreover, the economic recovery seems to be continuing strong. Manufacturing activity surged in March. CEO confidence reached a 20-year high, according to the Conference Board. And economists project U.S. growth of 3.5 percent to 4 percent next year, with the global economy expanding slightly faster.
When you look at stock valuations, it may be true that small growth companies and other hot stocks have shot up a little too fast. But whatever excesses exist in the sector, they're still nowhere near the bubble that developed in the late 1990s.
P/Es based on earnings estimates for this fiscal year. Growth based on earnings projections for the next five years, according to First Call. |
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Most important for long-term individual investors, big-cap growth stocks have largely been omitted from this binge of overvaluation.
Big stocks, with market capitalizations of more than $8.8 billion, are currently trading at P/Es averaging 18.2, while small stocks average an 18.6 P/E, according the Leuthold Group, an institutional investment advisory firm that tracks a universe of stocks divided by decile.
"This year is the first time since 1983-84 that small stocks have traded at a premium to big stocks," says Leuthold senior researcher Andy Engel.
Leuthold research also shows that stocks with above-average growth are relatively cheap, compared with their historical valuations.
The bottom line is that even if some narrow subsectors of small growth stocks are ahead of themselves, the long-term outlook for the market remains solid. And the types of stocks that should make up the core of individual investors' long-term equity portfolios are actually quite moderately priced.
You can see that for yourself just by looking at the Sivy 70 list of large, high-quality growth companies. I've gone through that list, looking for the stocks with superior prospects that look most attractively valued (I've omitted a few insurance stocks that aren't directly comparable). Six top picks are listed in the table above.
Michael Sivy is an editor-at-large for MONEY magazine. Sign up for free e-mail delivery every Monday and Thursday of Sivy on Stocks.
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