Don't sell this market short. Since the Dow Jones industrial average swooned 416 points on February 27, the market has become more volatile, but the overall direction has been up.

Both the volatility and the move higher should continue. Economic growth is slowing, and housing prices are likely to fall further, but a recession seems unlikely. The Federal Reserve is clearly more worried about inflation than recession, but inflation isn't a huge concern either. Look for the Fed to stay on the sidelines for many more months before it moves to lower short-term interest rates.

That doesn't mean it will be smooth sailing for stocks along the way. I can't recall a time when the market faced more potential pitfalls. The subprime mortgage mess, hedge-fund excesses, the budget and traded deficits, a plethora of geopolitical dangers -- any of these could worsen and spark a market selloff.

Mark Arbeter, chief technical strategist at Standard & Poor's, has two fascinating charts. One shows the current bull market, which began October 9, 2002. The other shows the 1982-87 bull market. I'm not much of a believer in technical analysis -- that is, sizing up the market's future direction on the basis of charts that describe past performance -- but it's hard not be struck by the similarities. Both charts show a virtually unbroken rise for nearly five years. We know what happened in 1987: The Dow plunged 22.6% on October 19, but the economy didn't fall into recession, and the market went on to new highs after a brief, though terrifying, bear market.

As was the case during the 1982-87 bull market, the current advance has continued without a single correction of 10%. Given that fact and the increased volatility since February's selloff, a sharp decline is likely at some point, says Sam Stovall, S&P's chief market strategist. "We think we're overdue for a bull market correction," he says.

But that doesn't alter Stovall's overall bullishness. "I think we have underestimated how strong this bull market is." The market is apparently anticipating a slowing in earnings growth this year followed by acceleration next year. S&P predicts operating earnings growth of only 2.9% for 2007 over the previous year. But Thomson First Call expects a healthy 11% rise in earnings in 2008 based on its survey of brokerage analysts.

The Leuthold Group, a Minneapolis-based research firm, is as good as anyone at the devilishly tricky business of market forecasting. Chuck Zender, a Leuthold analyst, says the firm is bullish. The chief reason: The data show that many people, professionals and ordinary investors, remain bearish. That's bullish because it means they still have lots of cash to invest. "People haven't gotten over the 2000-02 bear market," Zender says. "It's very vivid in their minds."

What's more, the market is reasonably priced. Stocks trade at about 15 times estimated 2007 earnings -- precisely the historical average price-earnings ratio. Bull markets usually end only when P/E ratios reach excessively high levels.

That doesn't mean excesses haven't hit parts of the market. High-yield (or "junk") bonds are clearly overpriced, as are real estate investment trusts (REITs). Although it's impossible to know when the party will end, it's time to cut back positions in those groups. It's not a bad time to reduce some of your emerging markets investments, too. I'd make them no more than 5% of your stock holdings.

Small-company stocks, in general, are expensive compared with stocks of larger companies. Based on estimated 2007 earnings, the price-earnings ratio of small caps is 9% greater than the P/E of large caps. Small caps normally trade at a discount to large caps and haven't reached such a lofty premium since 1983, the Leuthold Group says.

At funds in which it has substantial flexibility, T. Rowe Price has swapped many of its small-company stocks for stocks of larger companies. "When we look at small caps, the valuations can't be sustained," says Ned Notzon, head of the Baltimore firm's asset allocation committee. Price's personal strategy funds currently have just 7% of assets in small caps; that compares with 12% normally. "This is a very extreme position for us," Notzon says. I think it's a sensible one, though: This is a terrific time to trim your small-cap holdings. Limit them to no more than 10% of your stock holdings.

Common sense tells you that small caps shouldn't sell at higher P/Es than large caps. Small companies have fewer product lines, less access to capital markets and less margin for error. After leading large caps since 1999, small caps are due for a rest. "There are more risks in small caps," says Michele Gambera, chief economist for Chicago-based Ibbotson Associates. What's more, large caps and small caps tend to lead and lag each other for multi-year periods, so once small caps relinquish their lead, they are likely to trail for some time. "They tend to have booms and busts," Gambera says. So far this year through April 20, the small-cap Russell 2000 index is running neck-and-neck with the large-cap-oriented Standard & Poor's 500-stock index. They're both up around 5%.

So-called growth stocks, companies with high growth rates and relatively high P/Es, look more attractive than value stocks. It's time to lighten up on value funds, although the case here isn't as compelling as the case against small caps. "We have more conviction on small caps versus large caps," Notzon says. Still he says, "We think it's very likely that large-cap-growth stocks are going to do extremely well."

What to buy? Vanguard Primecap Core (VPCCX) is a great fund that emphasizes large, growing companies. So are Marsico Growth (MGRIX) and the more-concentrated Marsico Focus (MFOCX). Balance your large-company funds with Selected American Shares (SLADX), a more value-oriented fund. And keep 25% or more in Dodge & Cox International Stock (DODFX), which will give you all the emerging-markets exposure you need.

Steven T. Goldberg is an investment adviser and freelance writer.

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