Bounce-Back Rally Proves Little

3/7/2016


Helped by decent U.S. economic news, expectations of central-bank easing in Europe and Asia, and stabilization in oil prices, the major U.S. averages have extended their rebound from the lows reached in January and February. Also helping has been improvement in the credit markets, with yield premiums on low-rated corporate debt declining from the highs reached Feb. 11.

The Dow Industrials have rallied more than 7.5% from their Feb. 11 closing low of 15,660.18, while the Dow Transports have gained more than 13% from their Jan. 20 closing low of 6,625.53.

Those rallies have convinced some former skeptics. The percentage of bullish investment newsletters now exceeds the percentage bearish for the first time in seven weeks, according to Investors Intelligence. But several market technicians argue that such snap-back rallies happen often in bear markets, while bears partial to fundamentals argue that stocks are overvalued and corporate profits are not growing.

The technicians make a good point. While clearly significant from a Dow Theory perspective, the recent rebounds are consistent with a continuing bear market. In fact, the rebounds have merely retraced about half of the declines from November to this year's lows. For a return to the bullish camp, the Industrials or Transports need to hold above this year's lows on a significant pullback, then both averages need to close above the highs established in the current rally.

On the fundamentals, the bears are mostly right about profits. But price/earnings ratios roughly match the norms since 1994. As shown below, the median S&P 500 stock trades at 18 times trailing earnings — similar to the norm since 1994. Median 12-month earnings growth of 4.8% is about one-half of the norm.

Conclusion

Holding some extra cash on the sidelines still seems prudent. Until investors see more evidence that corporate profit growth will accelerate, stocks are likely to struggle. For now, as a partial hedge, our buy lists have 18% to 19% in a short-term bond fund.

Growth rates, not valuations, are the problem
S&P 500 Index
-- (Large-Cap) --
S&P MidCap
--- 400 Index ---
S&P SmallCap
--- 600 Index ---
S&P 1500
----- Index -----
Avg.
Median
Avg.
Median
Avg.
Median
Avg.
Med.
TRAILING P/E RATIO
Recent
20.2
18.4
20.5
18.0
22.6
18.9
21.2
18.5
Norm since 12/94
20.7
18.1
21.3
18.1
21.6
18.2
21.2
18.0
% of months lower
since 12/94
39
54
30
46
62
57
44
54
12-MONTH GROWTH IN EARNINGS PER SHARE
Recent (%)
2.6
4.8
2.0
2.6
2.9
2.9
2.6
3.6
Norm since 12/94 (%)
8.0
9.6
7.8
9.3
6.3
8.8
7.3
9.4
% of months lower
since 12/94
12
13
11
10
15
10
13
10
12-MONTH GROWTH IN SALES
Recent (%)
1.4
2.5
2.2
2.9
3.7
3.6
2.5
2.9
Norm since 12/94 (%)
7.5
7.1
8.6
7.7
8.1
7.4
8.0
7.4
% of months lower
since 12/94
12
12
12
12
14
13
12
12
Notes: Price/earnings ratios exclude numbers above 75 or below 0. Growth rates exclude increases or decreases of more than 75%. 
------------------- % 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 Index (large-cap)
Recent
11
17
20
19
33
Norm since 12/94
8
18
22
17
35
S&P MidCap 400 Index
Recent
8
19
22
18
34
Norm since 12/94
8
16
22
16
38
S&P SmallCap 600 Index
Recent
10
14
20
16
40
Norm since 12/94
9
16
19
15
41
S&P 1500 Index
Recent
9
16
21
18
36
Norm since 12/94
8
17
21
16
38

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