Outlook Not All Bad

5/21/2012


While recent market action has been discouraging — and a more substantial near-term correction would not be surprising — we are sticking with a mostly invested posture. As a partial hedge, our buy lists now have 13% to 16% in a short-term bond fund.

We have raised some cash in recent weeks, partly to lower risk and partly because of company-specific disappointments. But we will be looking for buying opportunities in high-quality stocks — and watching the averages for an upside breakout. The Dow Industrials and Dow Transports remain within 6% of this year's highs, and a move above those respective levels of 13,279.32 and 5,368.93 would reconfirm the bullish primary trend.

Rearview mirror

With the debt crisis in Greece coming to a head, fears regarding a broader break-up of the euro zone escalating, growth in China and India decelerating, and the U.S. seemingly stuck in a slow-growth mode, investors have no shortage of reasons to worry. While we don't want to minimize these threats, it's worth remembering that the three primary drivers of stock prices remain favorable:

Inflation. The Consumer Price Index for April was up 2.3% from a year earlier, the smallest increase since February 2011. Excluding volatile food and energy, prices were up 2.3%. With U.S. wage growth sluggish and commodity prices slumping, a near-term surge in inflation seems unlikely.

Interest rates. Mostly because of a flight to safety but partly because of the favorable inflation numbers, bond yields have retreated close to the lows reached in 2011.

Corporate earnings. March-quarter earnings for the S&P 500 Index reached a new quarterly record, and trailing 12-month operating earnings per share are well above the former highs reached in 2007.

While stocks discount the future, not the past, investors should not overlook the positives amid today's blur of negative headlines. With corporate earnings trending higher and average price/earnings ratios below historical norms, U.S. stocks look like a better choice than cash or bonds for the long haul. For new buying, particularly attractive names include Intel ($27; INTC) and Macy's ($37; M).


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