Dow Industrials Stabilize

2/2/2009


Stocks have gained some support, with financials rebounding on reports the Obama administration will propose a plan to buy troubled assets from banks. Near-term trading will be dominated by earnings reports, developments in Washington, and the outlook for the banking sector.

A breakdown below the November low of 7,552.29 in the Dow Industrials would reconfirm the bearish primary trend, while continued resilience through earnings season would be encouraging. For now, subscribers should maintain a somewhat defensive posture, with 25% to 35% of equity portfolios in short-term reserves.

Downbeat results
December-quarter earnings reports have been weak overall, and several high-profile stocks have tumbled on very poor reports. But the major averages and most sectors of the market have moved higher since earnings season began, suggesting expectations of weak results were already reflected in stock prices.

With nearly one-third of S&P 500 companies having reported, about 40% have fallen short of consensus profit estimates — nearly double the long-term average of 23%. The financial sector has accounted for most of the worst shortfalls, but such industry leaders as AT&T ($26; T) and Microsoft ($18; MSFT) have also come up short.

On average, the share-price declines of companies missing expectations have been more substantial than the share-price rallies of those exceeding expectations. But, outside the financial sector, the downside surprises have not triggered massive sectorwide declines.

The financial sector, down more than 25% year-to-date as recently as Jan. 22, has bounced on reports that President Obama is considering the creation of a “bad bank” that will buy distressed and illiquid securities from banks. The market’s early reaction to this idea must be viewed as encouraging, though it remains unclear whether such a program would excise the rot in our financial system.

Conclusion
As a partial hedge, holding 25% to 35% of your equity portfolio in a short-term bond fund remains prudent. But you should continue to look for opportunities on a stock-by-stock basis, emphasizing attractively valued growers.

Look for companies exceeding consensus expectations, and don’t be afraid to buy stocks that have rallied on a better-than-expected earnings report. Among Forecasts recommendations, General Dynamics ($56; GD) rallied on a strong earnings report but remains attractively valued.


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