Our Game Plan


The heart of earnings-reporting season began with stocks at a bit of an impasse. The violent selling in such formerly highflying groups as biotechnology and internet commerce has shown it can impact the broader market, but to date the damage has been modest.

Most of the major averages are less than 5% from all-time highs, and we'd view a breakout above 16,576.66 in the Dow Industrials and 7,695.51 in the Dow Transports as quite bullish. Without new highs in the Industrials, we'd view a breakdown below the Feb. 3 closing lows of 15,372.80 and 7,053.75 as a bear-market signal.

Does it make sense to set your stock-market exposure based solely on the action of two price-weighted averages?

Of course not. But it always makes sense to listen to the averages, and the Dow Theory is a time-tested method of putting market action in perspective. As we consider how we'll respond to an upside or downside breakout in the averages, we're keeping the following in mind:

The primary trend. While the state of the Dow Theory is clear, nothing says the Industrials and Transports must be used to the exclusion of all other market measures. Like the Transports, the S&P 500 Index of big stocks and Wilshire 5000 Index of all stocks are 2% to 3% below the highs reached April 2. Similarly, advance-decline lines for stocks in the S&P 500 and S&P 1500 indexes are just a few good days from all-time highs.

Our take: A positive reaction to first-quarter earnings could put to rest any doubt regarding the market's trend and the majority money opinion.

The market's valuation. While poor timing tools, price/earnings ratios can provide perspective on the market cycle — and show how much upside is possible with a breakout to new highs. At roughly 15 times expected year-ahead earnings, the S&P 500 Index trades at a 10% premium to the 10-year norm — not bad considering today's low interest rates and low inflation. The median S&P 500 stock trades at more than 19 times trailing earnings, above the norm of 18 since 1994. Small and midcap stocks are more expensive.

Our take: The typical U.S. stock is expensive, but we don't see valuations as an absolute roadblock to further gains – assuming profits keep growing and bond yields don't surge.

The opportunities available in individual stocks. On average, the stocks on our buy lists have both lower valuations and superior growth rates relative to the typical U.S. stock, though much of our advantage reflects superior year-ahead expected profit.

Our take: We don't need to stick with the slow-growing giants in the S&P 500 to find good values, but our growth-at-a-good-price approach won't look nearly as good if profits stall for the broad market.

Investor sentiment. Everybody knows that March-quarter profits for the S&P 500 Index are projected to be roughly flat with the year-earlier quarter, and everybody knows results will beat consensus expectations. What nobody knows is exactly what investors are really expecting for 2014 and 2015 profits.

Our take: Every earnings season is crucial, but the market's reaction to March-quarter results and guidance could be especially telling. While sentiment gauges suggest bullishness has waned since year-end, we'd view a failure to rally on seemingly good news as a discouraging omen.


We are nearly fully invested, with more than 95% of our buy lists in stocks, so a move to new highs won't mean a big shift in our portfolios. With a bear-market signal under the Dow Theory, our stock-market exposure will be cut to 80% or less.

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