Attractive Stocks In Short Supply

5/9/2016


U.S. stocks have been under pressure since April 20, with energy and materials stocks suffering from profit-taking and renewed doubts about China and the global economy. For now, we're maintaining a somewhat defensive posture, with about 22% of our buy lists in a short-term bond fund.

Growers in short supply

As always, our recommended equity exposure depends on the market's primary trend under the Dow Theory, investor sentiment, valuations, and the opportunities available in individual stocks.

We view the primary trend as bearish, with the last confirmed signal in the averages a breakdown to significant lows earlier this year. Investor sentiment is neutral — not especially bearish or bullish, based on surveys and mutual-fund inflows. Valuations appear stretched, with the median stock in the S&P 500 Index trading at a trailing price/earnings ratio about 11% higher than the norm since 1994.

In addition, it has become tougher to find cheap stocks. As shown in the table below, the percentage of S&P 500 stocks with trailing P/E ratios below 14 is well below historical norms.

Reflecting today's stretched valuations and weak corporate earnings growth, we're having a harder time finding opportunities in individual stocks. As shown below, the median S&P 500 company reported a sales increase of 3.0% in the most recent quarter, or roughly half the norm since 1994. The median change in per-share earnings was 2.3% — well below the norm of 9.3%.

While we can still find some high-potential stocks, building a diversified portfolio of attractively valued growers has become more difficult.

Conclusion

If interest rates and inflation remain low, a revival in corporate earnings growth could revive the bull market. But expect us to maintain a somewhat defensive posture until the outlook for earnings improves and the Dow Theory returns to the bullish camp.


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