Waiting On The Transports

3/2/2015


With the Dow Industrials and broad market at all-time highs, now seems an opportune time to revisit the key drivers of our stock-market exposure:

The Dow Theory. A close in the Dow Transports above their December all-time high of 9,217.44 would reconfirm the market's bullish primary trend. Without new highs in the Transports, a breakdown below the Jan. 30 closing lows of 17,164.95 in the Industrials and 8,649.32 in the Transports would represent a bear-market signal.

Market valuations. When valuations are rich, the risk of a correction morphing into a bear market is greater. At 17 times expected year-ahead earnings, the S&P 500 Index's forward P/E ratio is at its highest level since 2004. The average forward P/E over the past 15 years is 16, according to FactSet.

On trailing P/E, the median S&P 500 stock trades at an 11% premium to the 20-year norm. That compares to 15% premiums for the S&P MidCap 400 and S&P SmallCap 600 indexes. Premiums for all three indexes are even higher based on price/sales and price/cash flow.

While valuations could certainly move higher, it's very tough to argue that U.S. stocks are cheap — unless you compare them to bond yields. At 3.0%, the spread between the median S&P 500 stock's earnings yield (earnings/price ratio) and the 10-year Treasury bond yield is well above the 20-year norm of 1.3%.

Investor sentiment. When investors are unusually bullish, the risk of a correction is greater. Among investment newsletters, bullish sentiment is unusually high. The percent of bulls is 59.5%, near the 60% level that Investors Intelligence terms dangerous. Individuals are also more bullish than usual, according to the American Association of Individual Investors.

The opportunities available in individual stocks. We are still finding reasonably valued growers, partly because the typical U.S. stock has better operating momentum than the capitalization-weighted S&P 500 Index. The median company in the broad S&P 1500 Index reported 7.7% year-to-year growth in per-share earnings in the most recent quarter, versus the 20-year norm of 9.0%. Median sales growth of 6.2% exceeds the 20-year norm of 6.1%.

Our growth-at-good-price approach is working nicely, with high Quadrix Overall scorers outperforming consistently since mid-2012. As shown on the right, our buy lists are again outperforming the S&P 500 Index so far in 2015.

Conclusion

We are likely to boost our equity exposure slightly if the Transports close above 9,217.44. For now, we're holding about 85% of our buy lists in stocks.


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