Bulls Still In Charge


With economic reports and speculation regarding Federal Reserve policy likely to drive near-term market action, subscribers should maintain an opportunistic and nearly fully invested posture. The Dow Theory is squarely in the bullish camp. Our buy lists have at least 91% in stocks, with the remainder in a short-term bond fund.

Positive response

Stock-market commentators seem mostly unimpressed with June-quarter results. Earnings are exceeding consensus estimates by the smallest margin in years, and profits for the S&P 500 Index are expected to show just 4.1% year-to-year growth for the quarter. Excluding the banking sector, earnings for the index are expected to be down marginally.

Yet stocks have responded positively, with all of the major averages up since the beginning of earnings season. Consensus estimates still project year-to-year profit growth for the S&P 500 Index of more than 5% for the September quarter and 11% for the December quarter, and the index remains reasonably valued at 14.5 times expected year-ahead earnings — not much above the 10-year norm of 14.1, according to FactSet.

But near-term profit estimates are under pressure, and recent history suggests expectations for the December quarter will be cut substantially over the next five months. Moreover, the valuation of the capitalization-weighted S&P 500 Index is being weighed down by its largest members.

Among the largest 50 S&P 500 stocks, the median expected current-year price/earnings ratio is 15.5, roughly in line with the norm since early 2004. But the median for the entire index is 16.8, versus the norm of 15.6. For the broader S&P 1500 Index of large, midcap, and small stocks, the median of 17.9 is well above the norm of 16.5.

On nearly all valuation measures except dividend yield, the median stocks in the S&P 500 and S&P 1500 trade at premiums to 10- and 15-year norms. Continued robust dividend growth would be very bullish, as dividend yields remain attractive relative to bond yields on a historical basis.


Stocks are no longer cheap, and at some point earnings growth will need to accelerate to sustain the market's advance. But for now U.S. stocks continue to attract money from around the globe, and we are still finding reasonably valued stocks supported by solid profit-growth prospects. For new buying, Cognizant Technology ($72; CTSH) and Lear ($69; LEA) represent top picks for year-ahead returns. Among more defensive names, CVS ($61; CVS) is a top choice for both near- and long-term gains.

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