Waiting On The Transports

7/18/2016


The Dow Industrials and S&P 500 Index closed at all-time highs, while the Dow Transports moved within 3% of the April 20 closing high of 8,109.19. A close above that significant high would indicate that the Transports are in an uptrend — and that the primary trend is bullish under the Dow Theory.

With a close above 8,109.19, we intend to lift our stock-market exposure, probably to at least 90%. For now, we're holding 80% to 81% of our buy lists in stocks, emphasizing attractively valued growers.

While safe stocks like consumer staples and utilities look expensive, many growers with some cyclical exposure seem reasonably valued — if they can meet expectations for 2016 and 2017 earnings growth. Amerco ($389; UHAL) and Southwest Airlines ($42; LUV), both with little foreign exposure, stand out as top picks on this theme.

Growth cyclicals and other growth stocks, including somewhat volatile health-care groups, have shown improved relative strength in recent trading. Centene ($72; CNC) and Laboratory Corp. of America ($136; LH) represent our top health picks.

Bond yields versus stock prices

Sometimes things get repeated so many times they are taken for fact, even when they amount to little more than generalizations. That's especially true on Wall Street, where well-worn maxims often substitute for historical perspective.

The latest example: warnings that bond yields should not be at record lows when stock prices are at record highs. One or the other market must be right, goes the logic. In other words, low yields and the narrow yield spread between short- and long-term bonds are inconsistent with expectations of a growing economy which are typically necessary for a healthy stock market.

But U.S. bond yields reached new lows on the day the June employment report said the economy added a robust 287,000 jobs — the biggest positive surprise since 2009. That suggests bonds are responding to factors external to the U.S. economy, including central-bank bond purchases in Japan and Europe.

With 10-year bond yields below 0% in Germany, Japan, Switzerland, Denmark, and the Netherlands, the 10-year Treasury note's yield of 1.5% looks pretty good in comparison.

If U.S. bond yields have dropped because of low inflation expectations and foreign demand, not because of a worsening outlook for the U.S. economy, the rally in stocks makes sense. While recent U.S. economic news has been mostly good, we'd like to see June-quarter results for clues about the outlook for corporate profits. Also, we'd like to see the Dow Transports, historically a good barometer for the more cyclical parts of the U.S. economy, rally above their April high of 8,109.19.


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