Too Soon To Sell

3/4/2013


With share prices vacillating after an impressive three-month rally, now seems a good time to focus on some basics. For our money, stock-market exposure should be set after answering five basic questions.

1. Is the primary trend bullish or bearish? The Dow Industrials reached fresh five-year highs on Feb. 27, while the Dow Transports reached all-time highs on Feb. 19, so the primary trend is clearly in the bullish camp under the Dow Theory. While a move to all-time highs in the Dow Industrials and S&P 500 Index could help extend the market's run in the near term, all-time highs are not necessary to keep the Dow Theory in the bullish camp.

2. Are stocks cheap? The Dow Theory cannot tell you the duration of a bull market. But stocks tend to be expensive at the end of bull markets, so valuations can help provide perspective. At 13.5 times expected year-ahead earnings, the S&P 500 Index is trading at a discount to long-term norms. But the forward P/E is being weighed down by discount valuations for the index's biggest stocks — and by expectations of a return to double-digit earnings growth in the September and December quarters. Still, with the median S&P 500 stock at 15 times expected year-ahead earnings — a 4% discount to the norm since 2004 — valuations appear reasonable assuming profit expectations are somewhat realistic.

3. Is sentiment unusually bullish or bearish? When investors become especially exuberant, the risk of a secondary correction or bear market tends to be higher. Surveys of individuals, newsletter editors, and portfolio managers reveal an above-normal level of optimism, though the rampant bullishness of early February has diminished as stocks moved sideways.

4. Are share prices extended? Judging by the percentage of stocks on the New York Stock Exchange trading above their 200-day moving average — 75% — the risk of a market pullback is relatively high. A typical one-third to two-thirds retracement of the advance since mid-November would put the Dow Industrials at 13,525 to 13,035.

5. Are quality stocks available at reasonable valuations? Partly because of a broad slowdown in earnings growth, the number of stocks that rate well under our growth-at-a-good-price approach has dropped. As shown below, 53 companies in the S&P 500 with trailing P/E ratios below 15 delivered year-to-year growth of at least 5% for sales and per-share earnings in the most recent quarter — below the norm of 57 companies since 1994.

Conclusion

While a secondary correction would not be surprising, the weight of the evidence suggests it is too soon to raise cash aggressively. Our buy lists have 91.9% to 97.5% in stocks.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com