Waiting On The Transports
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.
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.