Transports In Holding Pattern

2/14/2011


Helped by encouraging profit trends and takeover activity, the Dow Industrials and S&P 500 Index have reached fresh highs. But the Dow Transports, stalled beneath their Jan. 13 closing high of 5,229.47, have not confirmed the move to new highs. While this divergence is worth watching, we are maintaining a mostly invested posture, for the following reasons:

• The Transports, after gaining 27% from Aug. 31 to Jan. 13, trade less than 3% below 5,229.47. Considering the risk posed by unrest in the Middle East and higher energy prices, the Transports have shown decent resiliency.

• The broad market is moving higher with the Industrials. With the exception of the Transports, the market's reaction to December-quarter results has been encouraging. Advance-decline lines indicate most stocks have participated in this year's rally, and nine of the 10 S&P 500 sectors had year-to-date gains through Feb. 8.

• Our growth-at-a-good-price approach is working. In a switch from most of 2010, stocks with high Quadrix scores for Momentum (recent operating results), Earnings Estimates (trends in analyst estimates), and Performance (recent shareholder returns) have outperformed since Sept. 30. Partly as a result, high Overall scorers have also outperformed.

• We continue to find attractively valued stocks supported by operating momentum and solid growth outlooks. The S&P 500 Index trades at 13 times expected 2011 earnings — a reasonable multiple relative to historical norms. More important, many individual stocks trade at discounts to historical norms despite outstanding operating momentum.

Portfolio advice

Reflecting this week's downgrade of Sigma-Aldrich ($61; SIAL), our Long-Term Buy List has a 16.6% position in Vanguard Short-Term Investment-Grade ($10.74; VFSTX). Our Buy List and Focus List have 12.2% in this relatively low-risk bond fund, and our current plan is to target a roughly 10% to 15% bond-fund position.

We are likely to remain near this range if the Transports close above 5,229.47. But a move to confirmed new highs followed by a market pullback would be an opportunity to put more money into stocks. Conversely, if the Transports fail to reach new highs, a broader market pullback would be a discouraging development.

While you should keep an eye on the averages, also look for opportunities on a stock-by-stock basis. Shares of high-quality tech companies have shown improved relative strength, and we continue to like such blue chips as Apple ($355; AAPL), IBM ($166; IBM), and Texas Instruments ($35; TXN).


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