While housing and jobs improve as the economy gets going, equities move in anticipation of better times to come. For proof, see the double-digit gains the S&P 500 posted this year.
The "strengthening economy" theme, though, is already played out. Standard & Poor's says that U.S. shares are likely to keep climbing, but only by a modest 7% or so by late 2014.
Why? Valuations "are definitely not compelling," says Sam Stovall, chief equity strategist for S&P Capital IQ. The price/earnings ratio for equities jumped from a not-exactly-cheap 19 in January to 22, based on five years of average profits.
A rising P/E reflects higher expectations. Investors are paying more for stocks because they think earnings will grow even faster. To make money in this market, your stocks have to deliver profits. Or you must go with cheaper shares that have a greater margin for error.
THE STRATEGY: Add a foreign accent
In an increasingly expensive market, look for bargains. U.S. and international equities used to trade at similar levels, but today overseas stocks are about 20% cheaper based on five-year average profits. Says Paul Zemsky, chief investment officer for multi-asset strategies at ING Investment Management: "Europe is just beginning its recovery and is a lot less expensive than the U.S."
YOUR BEST MOVE
Boost your bet on Europe. Zemsky recommends increasing your foreign-equity stake by five to 10 percentage points. So if you normally keep 25% of your stock portfolio abroad, sell some of your domestic holdings, which have had a remarkable five-year run, and raise your foreign weighting up to 35%.
You can use MONEY 70 pick Dodge & Cox International ( (Avg. P/E: 14.3), with more than 75% of its assets in Europe. For an even more targeted approach, go with )Vanguard FTSE Europe ETF ( (Avg. P/E: 14.2). )
THE STRATEGY: Focus on revenue
As the economy accelerates, trim your exposure to defensive areas such as consumer stocks and utilities. Stick instead with sectors likely to see rising global demand, says R.W. Baird strategist William Delwiche.
YOUR BEST MOVES
Think industrials. Greg Thomas -- whose ThomasPartners dividend growth strategy, available through Schwab, beat the S&P 500 over the past decade -- favors global blue chips such as United Technologies (Fortune 500) (Avg. P/E: 16.5). Top holdings of , Industrial Select SPDR ETF ( (Avg. P/E: 17.5) include )GE (Fortune 500) and UTX. ,
Think technology. Business spending is expected to pick up in 2014, says Russell Investments chief economist Mike Dueker. And the productivity-enhancing tech sector will benefit. Jeff Layman, chief investment officer at BKD Wealth Advisors, favors firms such as Cisco Systems (Fortune 500) (Avg. P/E: 11.0) that provide infrastructure parts and services, not consumer companies. Cisco, Qualcomm, and Intel are among the top stocks in the , Technology Select SPDR ETF ( (Avg. P/E: 15.8). )
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