Profit Trends Support Bulls

11/15/2010


With the recent breakout in the Dow Industrials and Dow Transports to the highest levels in more than two years, the Dow Theory is unequivocally bullish. While the Dow Theory cannot forecast the duration or magnitude of a bull market, it can provide perspective on where we are in the market cycle.

Dow Theorists divide bull markets into three phases: the first represents a revival in investor confidence; the second reflects improvement in corporate earnings; and the speculative third stage is when stocks advance on hopes and expectations.

These stages are often separated by corrections, so an optimist could argue that we have just entered the second stage of the bull market that began in March 2009. That may seem preposterous with the Dow Industrials up 74% from the March 9, 2009, closing low, but profit trends provide grounds for optimism.

With more than 80% of S&P 500 components having reported, September-quarter earnings for the S&P 500 Index are on track to be up 31% from year-earlier levels. For the sixth straight quarter, more than 70% of S&P 500 companies exceeded consensus profit expectations.

More important, consensus estimates for the December, March, and June quarters have edged higher since Oct. 1. According to Bloomberg, the October spread between the number of U.S. companies lifting guidance and the number lowering guidance was the most favorable in at least 10 years.

Consensus estimates now project per-share earnings for the S&P 500 Index will rise 37% to $85 for 2010 and 13% to $96 for 2011 — above the record $88.18 in 2006.

The 2011 consensus seems high given the headwinds facing the U.S. economy. But globally diversified U.S. companies also have some tailwinds, including a depreciating U.S. dollar, robust growth in developing nations, and favorable labor-cost trends. U.S. unit labor costs have declined in five of the past seven quarters, according to the Bureau of Labor Statistics.

The S&P 500 Index trades at less than 13 times expected 2011 earnings — modest versus 20-year norms and downright cheap relative to today’s interest rates. One fly in the ointment: The typical U.S. stock is not as cheap as the capitalization-weighted S&P 500 Index, partly because the big stocks that dominate the index are unusually cheap relative to the broad market.

Conclusion

With stocks and investor optimism up sharply since August, a near-term market pullback would not be surprising. But, with the Dow Theory in the bullish camp and quality stocks available at reasonable valuations, we are inclined to view any such pullback as a buying opportunity. For now, we’re keeping 16.6% to 18% of our equity portfolios in a short-term bond fund.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com