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As Expectations For 3Q Earnings Season Fall, What's The Best Investment Strategy?

Investment risk for the very near-term stock market is going up. There's been pressure on interest rates, investor sentiment was hit by the lack of tapering to quantitative easing, and finally, the third-quarter earnings outlook is mediocre at best.

Everything related to the stock market has been exceptional this year. While earnings growth was completely and totally lackluster, with several exceptions, the main stock market indices proceeded to rise tremendously based on continued monetary expansion and the fact that there really is nowhere else for investors to go but stocks.

Second-quarter earnings season was unimpressive, and I think it will be the same for the third-quarter reporting season. Financial results very well could be the catalyst for a major market retrenchment in October. I think that all investors need to prepare for such an eventuality. Generally speaking I do think that stocks can continue to rise in 2014; however, corporations will have to provide genuine earnings growth and top-line growth to keep valuations from pushing the envelope.

I would say that, given current earnings and expectations for 2014, the stock market is at least slightly-if not fully-overvalued at present. With the expectation of very modest earnings growth in the third quarter and little in the way of sales growth (especially among large-cap companies), recent stock market strength has been an expansion of valuations only.

This is why I'm so cautious near-term and why October could be a wild ride for share prices.

It is quite likely that market leaders that did well in the first two quarters of this year will continue to do so. These are the Johnson & Johnson's (NYSE:JNJ) of the equity market universe-these are the companies that have been well bid by institutional investors. (See "Consistency, Rising Dividends Make This Benchmark A Possible Winner for Savers.")

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