Bullish or bearish? Be both

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If you find yourself nodding in agreement with bullish and bearish views of the stock market, feeling unable to commit to either a future rally or a correction, try gearing up for both.

Brian Belski, chief investment strategist at BMO Nesbitt Burns, calls it the portfolio barbell, where you make aggressive bets on a rising market and defensive bets on trouble ahead.

"This approach should help investors capitalize on periods of market strength and also guard against any potential market pullbacks," he said in a research note.

The strategy looks particularly appealing right now, given that the S&P 500 is stuck in an unusually tight trading range, which suggests a lack of conviction among investors. According to Bespoke Investment Group, the index's high and low points over the past three months are less than 5 per cent apart, versus a historical average of more than 13 per cent.

The aggressive part of Mr. Belski's barbell strategy consists of stocks that offer attractive growth characteristics but trade at reasonable valuations and are relatively underappreciated by the market. Specifically, they have outperformed the S&P 500 over the past month and underperformed it over the preceding three months. Their price-to-earnings ratios, relative to expected growth over the next two years, should be lower than the S&P 500.

These stocks tend to beat the index when the broader market is rising, particularly during the latest surge since mid-2012, and also do reasonably well when the market is stuck in a tight trading range. Some current examples include Aetna Inc., Gilead Sciences Inc. and Home Depot Inc.

For the defensive end of the barbell, Mr. Belski focuses on dividends. Yes, yields should be greater than what is offered by the S&P 500, but he also likes stocks that have superior one-year dividend growth and strong free cash flow to ensure that the dividends are sustainable and likely to rise.

These stocks perform very well over time, but really shine relative to other stocks when the broader market is struggling. Since 1990, this approach has gained an average of 2.6 per cent during market pullbacks, making them ideal holdings in the event of a correction. Some current examples include Abbott Laboratories, Archer-Daniels-Midland Co. and General Mills Inc.

"Although we do not envision any sort of major U.S. market meltdown in the coming months, we do expect volatility to increase, which is likely to keep the market in a fairly wide trading range," Mr. Belski said.

Of course, a large part of the attraction of this barbell strategy comes from the fact that market conditions can inspire two very different views of the future. The bullish view rests on solid profit growth, strong corporate balance sheets, reasonable share price valuations (based on expected earnings), accommodative central banks and a recovering global economy. The bearish view rests on the fact that stocks haven't suffered a correction in three years, are expensive when earnings are averaged over a 10-year span and vulnerable to a sharp downturn when the Federal Reserve raises its key interest rate – expected next year.

Of course, bullish and bearish views of the market are always on display. But with the S&P 500 up more than 185 per cent over the past five years amid an extraordinary time for the global economy, the decision to either raise or lower your exposure to stocks has the potential to make a big impact on your portfolio.

Mr. Belski's barbell approach is designed to remove the risk of making the wrong move – and allows you to agree with the bulls and the bears.