Blue Chips Buoy Bulls

2/13/2012


Helped by breakouts in such giants as IBM ($193; IBM), Microsoft ($30; MSFT), and Wal-Mart Stores ($62; WMT), the Dow Industrials have surged to their highest level since May 2008. The Dow Transports have moved within 6% of their 2011 all-time high of 5,618.25, while the S&P 500 Index is within 2% of its 2011 high of 1,363.61.

We'd view moves above those levels as encouraging, and we suspect that fresh three-year highs in the benchmark S&P 500 could convince some skeptics to jump on board. But the Dow Theory turned bullish in December when the Industrials and Transports moved above the October highs, and a near-term correction from current levels would be consistent with a continuing bull market. Our buy lists have 87.6% to 90.1% in stocks.

Dogs that did not bark

For those inclined to view the market's year-to-date surge as mere evidence of hope springing eternal, it's worth remembering the bearish case heading into 2012 — and noting what has not happened so far this year:

The run of solid U.S. economic data has not petered out. In fact, two healthy employment reports suggest the labor market may be turning a corner. Manufacturing data points to continued strength, and loan growth has resumed at big U.S. banks.

Economies overseas have not worsened considerably. Data related to China suggests the world's second-largest economy is slowing but not headed for a hard landing. So far, late-2011 fears of a steep recession in Europe appear to have been overdone.

Interest rates have not moved higher. Despite the mostly better-than-expected economic data, yields on Treasury and corporate bonds are roughly unchanged so far in 2012. The Federal Reserve's latest statement suggests it will engage in more bond purchases if the U.S. economy fails to accelerate.

Also worth noting: One argument of the bears has gained some support from the data, as disappointing profit margins have contributed to a lower-than-normal percentage of companies exceeding consensus profit estimates. Since year-end, consensus expectations for December-quarter earnings have been reduced for seven of the 10 sectors in the S&P 500 Index. Year-to-year earnings growth for the index is now expected to slow below 3% in the March quarter, according to Thomson Reuters.

With potential profit pressures in mind, we'll be paying close attention to the action in the Transports and other cyclical groups. Continued strength in these economically sensitive stocks would suggest expectations for a pickup in earnings growth beginning in the June quarter are realistic. The Transports don't need to surpass 5,618.25 in the near term to keep us bullish, but their ability to rebound from any correction will be crucial.


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