Surging Dollar Pressures Stocks

3/16/2015


Stocks have slumped on worries regarding the soaring U.S. dollar and a potential interest-rate hike from the Federal Reserve, pushing the major averages back into the red for the year.

Without a close in the Dow Transports above 9,217.44, breakdowns below 17,164.95 in the Dow Industrials and 8,649.32 in the Transports would represent a bear-market signal, prompting us to raise more cash.

How much cash? Probably to at least 25% of our buy lists, up from the current 15%. Our cash position will depend on the action of the broad market, the market's valuation, investor sentiment, and the opportunities available in individual stocks.

The fallacy of division

Bears argue stocks are expensive, especially considering the S&P 500 Index's roughly 4% profit growth and 2% revenue growth in the December quarter, according to FactSet.

The bears are at least half right. No matter how you slice them, U.S. stocks are expensive — unless you compare them to bond yields. The median stock in the S&P 500 trades at 19.7 times trailing earnings, meaning one-half have P/Es higher than 19.7 and one-half are lower than 19.7. Today's median is 10% above the norm since October 1994 — and higher than 80% of month-ends since October 1994.

But the bears are wrong to extrapolate the S&P 500 Index's growth rates — weighed down by huge declines in the energy sector — to the broad market. Excluding energy, per-share profits for the index rose 6.8% on a 4.8% revenue gain in the December quarter, according to FactSet.


MEDIAN GROWTH RATES AND P/E RATIOS

Median Year-To-Year
Growth In Most
---- Recent Quarter ----
-- Median Trailing Ratio --
EPS
(%)
Sales
(%)
P/E
Price/
Sales
Recent median for S&P 500 stocks
9.1
6.0
19.7
2.1
Norm since Oct. 1994
9.6
6.1
18.0
1.5
Recent as % of norm
95
98
110
142
% of months lower since Oct. 1994
31
45
80
100

More importantly, the median S&P 500 company reported 9.1% year-to-year growth in per-share profits in its most recent quarter, only modestly below the norm of 9.6% since October 1994. While record stock buybacks are lifting per-share growth rates, median sales growth in the most recent quarter is 6.0% — in line with the norm since October 1994.

With decent growers available — and outright bargains in short supply — now seems a good time for our emphasis on reasonably valued growers. Fortunately, reasonably valued stocks are relatively plentiful. As shown below, 41% of S&P 500 stocks have trailing P/Es below 18, versus the 20-year norm of 49%.


BREAKDOWN OF S&P 500 TRAILING P/E RATIOS

-- % Of S&P 500 Stocks With Trailing P/Es Between . . . --
0 To 10
10 To 14
14 To 18
18 To 22
Above 22
Or NM
Recent
5
13
23
20
39
Norm since Oct. 1994
9
18
22
17
34
Recent as % of norm
57
69
101
123
117
% of months lower since Oct. 1994
27
16
50
79
67

Our Quadrix Overall score, which rewards companies with cheap valuations and strong fundamentals, seems well suited to today's market. The top one-fifth of stocks based on Overall score has outperformed the average stock for 22 consecutive rolling 12-month periods.

Conclusion

We intend to watch the averages while maintaining about 85% of our buy lists in stocks. We're also going to be monitoring the performance and availability of the kind of growth-at-a-good-price stocks we favor.


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