Bearish Trend Confirmed

10/10/2011


The Dow Industrials closed below the August low of 10,719.94, confirming a similar move in the Dow Transports and reconfirming the bearish primary trend under the Dow Theory. While the breakdown in the Industrials is discouraging — and we are decreasing our stock-market exposure this week by dropping BlackRock ($148; BLK) — we are not making a wholesale move out of stocks.

For now, our buy lists have about 25% in Vanguard Short-Term Investment-Grade ($10.63; VFSTX), a relatively low-risk bond fund. Of the portion of your portfolio allocated to equities for the long haul, we suggest you limit stock-market exposure at roughly 75%. If 75% seems high given the bearish reconfirmation, consider the following:

We're not all-or-nothing market timers. Shifting between 100% and 0% stock-market exposures is among the best ways to wreck your long-term returns, and we expect stocks to handily outperform bonds over the next decade. As a rule, we are unlikely to cut our stock-market exposure below 60%.

Stocks appear oversold, and investor sentiment is extremely pessimistic. Only 14% of NYSE stocks are trading above their 200-day moving averages, among the lowest readings since the market bottomed in March 2009. More than 45% of newsletters monitored by Investors Intelligence are bearish, the highest percentage since March 2009. With so many stocks down sharply and so many investors bearish, a little good news on Europe, the economy, or earnings could trigger a meaningful near-term bounce.

On average, stocks are fairly cheap. The S&P 500 Index trades at 10 times consensus 2012 profit estimates. Investors are rightly skeptical regarding the 2012 consensus, which calls for 13% growth. But the forward P/E is already below the norms seen in economic downturns over the past 50 years, according to Bloomberg. Based on trailing earnings, the average stock in the S&P 500 has a P/E of 15.5, below the norm of 20.5 since January 1990.

Cheap stocks are plentiful. The number of S&P 500 stocks with trailing P/Es below 12 has surged to 171 — the highest since June 2009 and above the norm of 80 since January 1990. Of course, P/Es can be misleading when profits are set to fall, so 2012 guidance will be especially crucial as third-quarter results are announced over the next few weeks.


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