As Earnings Arrive, Rally Broadens

10/26/2015


With the market outlook a bit muddier than usual, we find it helpful to focus on three core questions:

What is the primary trend? When both the Dow Industrials and Dow Transports surpass previous significant highs, the primary trend is presumed bullish under the Dow Theory. The mid-September closing highs of 16,739.95 in the Industrials and 8,215.44 in the Transports appear significant; both came after three-week rallies of more than 6.8% that retraced more than 40% of the preceding declines. So, when the average eclipsed those points in early October, we viewed the primary trend as bullish.

To be sure, we'd like to see some follow-through from the Transports, which have been hurt by a few downbeat earnings reports. But more groups are now participating in the rally, and the initial reaction to September-quarter results has been mostly positive so far.

➤ Are stocks cheap? Stocks don't look cheap — except when compared to bond yields. But stocks aren't particularly expensive, either. As the nearby table illustrates, the breakdown of cheap versus expensive stocks is roughly in line with 21-year norms. Of course, valuations depend importantly on expectations for corporate earnings growth, so watch the guidance provided with September-quarter results.

➤ Are quality stocks available at attractive valuations? We are having a harder-than-normal time finding buys in energy, materials, and industrials. But we continue to find attractively valued growers in the consumer-discretionary, health-care, financial, and technology sectors. Our buy lists have 75% to 78% in stocks. Top picks include Alaska Air ($75; ALK) and Jones Lang LaSalle ($151; JLL).

------------------------ % Of Stocks With Trailing P/E Of ------------------------
0 To 10
(%)
10 To 14
(%)
14 To 18
(%)
18 To 22
(%)
Over 22
Or NM
(%)
S&P 500 (large-cap)
Recent
7
17
22
21
32
Norm since 12/94
8
18
22
17
35
S&P MidCap 400
Recent
6
15
24
19
36
Norm since 12/94
8
16
22
16
38
S&P SmallCap 600
Recent
6
13
24
15
43
Norm since 12/94
9
16
19
15
41

Stocks with trailing price/earnings ratios below 10 represent about 7% of S&P 500 Index stocks, versus the norm of 8% since December 1994. Small and midcap stocks don't compare as favorably to historical norms but also don't look especially expensive.


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