Cash Position Reduced Slightly
While the S&P 500 Index has rallied to 10-month highs, the Dow Industrials and Dow Transports have not been able to surpass their respective April highs of 18,096.27 and 8,109.19. Still, we're slightly reducing our cash position to accommodate this week's addition of Mohawk Industries ($201; MHK). Our buy lists' exposure to a short-term bond fund has been cut to 16.5% to 17.2%, for several reasons.
First, as always, our recommended cash position depends on the primary trend, the market's valuation, investor sentiment, and the opportunities available in individual stocks. We see an opportunity in Mohawk, reviewed on page 6.
Second, we're encouraged by the broad market's action. The S&P 1500 advance-decline line, a running total of advancing minus declining stocks, has surged to all-time highs. The S&P 500, S&P MidCap 400, and S&P SmallCap 600 indexes have all rebounded from corrections this spring to reach year-to-date highs. Even the long-suffering Dow Transports have shown some strength, with rebounds in railroads and airlines pushing the average within 3% of 8,109.19.
Third, as explained in this week's cover story, surveys suggest investor sentiment is not overly bullish. Mutual-fund outflows also suggest individuals are viewing the rally since February with skepticism. If the S&P 500 and Dow Industrials break out to all-time highs, we would expect some skeptics to become believers.
Fourth, while U.S. stocks are not cheap, much of the overvaluation seems concentrated in a few sectors. As shown below, the average S&P 1500 stock trades at 22.9 times trailing earnings — about 8% higher than its norm since December 1994.
The average stocks in the consumer staples, health-care, telecom-services, and utilities sectors have trailing price/earnings ratios at least 13% higher than their norm since 1994. All four of these defensive sectors average Quadrix Value scores below their long-term norm, with average scores for consumer staples and utilities among the lowest on record.
By comparison, sectors with more exposure to the economic cycle — including consumer discretionary, industrials, and technology — have an average P/E in line or below their long-term norm.
A rally above the April highs of 18,096.27 in the Industrials and 8,109.19 in the Transports would be bullish. Movements in the averages should always be considered together, but new highs in the Transports would be particularly encouraging. Such a breakout would signal an improving outlook for cyclical companies. With cyclical stocks trading at relatively attractive valuations, such a signal would be good news indeed for those looking to put some cash to work.