Good News Still Good News

10/9/2017


Fueled by encouraging economic data, the Dow Industrials and Dow Transports have extended their run into record territory. While volatility may pick up when earnings-reporting season begins in mid-October, a constructive stance toward equities remains appropriate.

The Dow Theory is squarely in the bullish camp, and we continue to find enough attractively valued growers to build reasonably diversified portfolios. Reflecting this week's rank changes, our Focus List and Buy List now have 100% in stocks. Our Long-Term Buy List has 94%.

Sector rotation

While major benchmarks like the S&P 500 Index and Dow Industrials have advanced gradually, beneath the surface, stocks have seen considerable rotation.

Formerly out-of-favor groups like banks, autos, transportation stocks, value stocks, and small stocks have rallied sharply since mid-August. Former leaders like Alphabet ($967; GOOGL), Apple ($153; AAPL), Facebook ($168; FB) have stalled.

Industry-group rotation amid strength in the major averages is bullish, as it implies that new leadership can extend the market's advance. In our view, the fact that economically sensitive stocks have rallied is particularly encouraging, as such stocks had lagged for most of 2017.

Also encouraging: Stocks are still rallying on good economic news, suggesting investors don't expect the Federal Reserve to spoil the party with aggressive rate hikes. While investors now widely expect another interest-rate bump before year-end, the pace of increases will likely be gradual.

According to the Institute for Supply Management (ISM), service-sector activity surged to a 12-year high in September. The ISM's manufacturing index reached a 13-year high in September, helped by strong orders.

One concern is the rising level of bullishness. As legendary investor Sir John Templeton said, "Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."

While it seems hard to argue we've reached the euphoria stage, some sentiment measures are flashing yellow. Bullishness among investment newsletters has surged, while optimism among individuals has seen an uptick.

Conclusion

Is investor optimism running ahead of reality? The reaction to September-quarter earnings should help answer that question, as a positive reaction to the results would bode well for the near term.


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