Averages Reach Fresh Highs

1/10/2011


Stronger-than-expected economic data has helped lift the Dow Industrials and Dow Transports to fresh highs. A near-term pullback would not be surprising as December-quarter earnings season gets underway, but the Dow Theory is squarely in the bullish camp. And while we'd prefer to shift more money into stocks on a market pullback, we intend to look for opportunities on a case-by-case basis.

Reflecting this week's changes, the Buy List and Focus List have 12.2% in Vanguard Short-Term Investment-Grade ($10.77; VFSTX). Our Long-Term Buy List has 14.3% in this low-risk bond fund. With the remaining 85.7% to 87.8%, we're emphasizing high-quality stocks with attractive valuations and above-average operating momentum. Top picks include Agilent ($41; A) and Ameriprise Financial ($59; AMP).

Two questions

With the Industrials and Transports at the highest levels in more than two years, the market's primary trend under the Dow Theory is not in question. Today's biggest dilemmas, at least for Dow Theorists, relate to two questions:

Have we reached the speculative third stage of the bull market, when share prices outrun underlying values? Bull markets tend to end in speculative excess, and the first decline after such a period often gives back a big chunk of the preceding advance. So, even if the averages are in unambiguous uptrends, it can make sense to head for the exits if you're convinced stocks are overpriced.

Have stocks come too far too fast? Secondary market corrections are usually blamed on news developments, but the real cause is often a top-heavy market, with too many bulls and too many traders holding stocks in anticipation of short-term gains.

Our answers

We're not convinced stocks are overpriced. As explained on this page last week, the median U.S. stock is trading in line with 15-year norms for price/earnings and price/cash flow ratios. Capitalization-weighted indexes like the S&P 500 remain cheap relative to historical norms, partly because the largest stocks are cheap. Relative to interest rates, stock valuations remain attractive versus historical norms. Of course, all such valuation questions hinge on the profit outlook, which we view as favorable.

We're worried about the potential for a near-term pullback, partly because sentiment indicators point to widespread optimism and partly because stocks seem extended. The percentage of NYSE stocks trading above their 200-day moving average is nearing the 80% level that has often represented a yellow flag for the market. A 12.2% to 14.3% cash position should help us take advantage of opportunities in beaten-down names.


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