A popular CNBC commentator recently remarked that it was very easy to remain "bullish in theory." Indeed, the conceptual case for owning stocks is strong thanks to improving profits, increased M&A activity, strong corporate free cash flow levels, and continued political support for the capital class.

Unfortunately, while it may be easy to remain aggressively long conceptually, investors cannot use theoretical profits to fund their retirements or kids' education. And as we all learned in the great bust of 2000-03, fundamentals like valuations, interest rates and profits do matter. Really, they do. So as my partners and I think about the opportunities in the equity markets, we must address these fundamental issues. In my opinion, applying these variables makes it more challenging to remain bullish in theory.

  • How high are stock valuations?
  • How much longer can corporate profit margins expand?
  • Where will interest rates be next year?
  • Are the stocks in my portfolio up a lot and fairly priced?
  • After observing a tremendous amount of good fundamental news priced into the wonderful bull market that began in 2002, I have become more ambivalent about the opportunities in the equity market. With the average stock up over 100% since the bull run started, and with the average price/earnings ratio approaching 20 times, the indices generally seem to be fairly priced to slightly expensive. Since valuation spreads have narrowed during this rally, fewer mispriced individual stocks exist. This does not mean that profits cannot be garnered in equities, but rather that profits will accrue less easily, and more to the nimble trader or fundamentally correct, disciplined investor. The indexer or buy-and-hold investor should find decent returns harder to come by.

    My cautious position for most of last year mitigated some excellent calls on individual sectors and stocks, and big profits were made in homebuilders, managed care companies and select positions in energy, industrial, consumer and technology stocks. There were also a few duds, mostly in the "tech turnaround" space.

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