Earnings Underpin Rally

2/20/2017


Stocks have rallied on optimism regarding corporate earnings, pushing the Dow Industrials and Dow Transports to fresh all-time highs. With the primary trend bullish and our growth-at-a-good-price approach working, we're sticking with a nearly fully invested posture. Our buy lists have more than 96% in stocks.

Bullish trend confirmed

The Dow Transports closed above their January all-time high in mid-February, confirming an earlier move to new highs in the Dow Industrials. When both the Industrials and Transports are reaching significant highs, the primary trend is presumed bullish — and higher stock prices are likely.

While only the Industrials and Transports figure in textbook Dow Theory analysis, nothing says the Dow Theory must be used to the exclusion of all other considerations. Recent new highs in the S&P 500, Nasdaq Composite, and Russell 2000 indexes are encouraging. Also encouraging: the overdue move to new highs in the S&P 1500 advance-decline line, a running total of advancing minus declining stocks.

Many credit Washington for the latest rally, with President Trump's Feb. 9 promise of a "'phenomenal tax plan"' helping spark the fresh highs. Depending on the assumptions used, Wall Street analysts figure a drop in the corporate tax rate to 20%, down from 35%, would boost per-share earnings for the S&P 500 Index by 5% to 10%. A one-time tax holiday for the repatriation of money held overseas would provide an additional per-share boost, as much of the money would likely be used to repurchase shares.

Stock prices and bond yields advanced steadily after Feb. 9, and there is little doubt that hopes for tax reform have helped stocks since Election Day. But stocks are also responding to positive earnings news, including a solid December-quarter reporting season and fairly stable consensus estimates for 2017 and 2018.

The technology sector, widely seen as among the least likely to benefit from tax reform because of its reliance on foreign sales, is this year's top performer. Indexes of commodity prices, helped by economically sensitive materials like copper and lumber, have rebounded close to 14-month highs. Stocks in Asia, Europe, and Latin America have rallied on earnings and economic news, with growth-sensitive emerging markets pacing the advance.

Conclusion

Events in Washington merit attention, but the bigger story for stocks is the improving earnings outlook. Subscribers should maintain a positive stance toward stocks, emphasizing reasonably valued shares supported by operating momentum and solid growth outlooks. Top picks include Alphabet ($837; GOOGL), Citizens Financial ($38; CFG), and VMware ($91; VMW).

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