Industrials near significant high

4/7/2008


The Dow Industrials have moved within 200 points of 12,743.19, and a close above that level would confirm the Dow Transports’ surge to significant highs. Unless the Transports close below 4140.29, a close in the Industrials above 12,743.19 would return the Dow Theory to the bullish camp. With such a bull-market signal, our cash position will be reduced to a range of 15% to 20%. For now, subscribers should watch the averages and hold 25% to 35% of equity portfolios in a money-market or short-term bond fund.

Stocks sometimes retreat temporarily after bull-market signals. But, considering today’s relatively pessimistic mood among investors and the oversold condition of the market, a breakout to new highs in the Industrials could trigger a scramble to buy among portfolio managers scared of being left behind. So, with a close above 12,743.19, the target weight for each of the 27 stocks on our Buy List will be increased to 3.0%, up from 2.5%. For the Long-Term Buy List, the target weight of each of the 33 stocks will be increased to 2.5%, up from 2.1%.

The bullish case
The bullish case for U.S. stocks can be described thusly:

(1) After a massive sell-off, financial stocks have stopped declining on bad news.

(2) Outside the financial sector, profit prospects have held up relatively well, partly because of signs of resilience in the global economy.

(3) With average price/earnings ratios on S&P 1500 stocks near 12-year lows, stocks are attractively valued considering the profit outlook and expectations that the U.S. economy will strengthen over the next year. Relative to bond yields, stocks look very cheap versus historical norms.

Crucial questions
Is the worst really over for financials? Are Wall Street’s profit estimates, which project 7% to 10% March-quarter profit growth for nonfinancial companies, realistic? Are consensus expectations for the world economy, which still call for solid economic growth of at least 4% for 2008, realistic?

As profit warnings and profit reports are released in coming weeks, market action should go a long way toward answering these questions. Recent strength in the Transports, a good barometer of the outlook for economically sensitive sectors of the economy, supports the bullish case. But a close above 12,743.19 in the Industrials is required to confirm that the tide has turned, that the majority money opinion is now discounting an improved environment for stocks.


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