For Now, Remain Skeptical


Helped by Federal Reserve Chair Janet Yellen's assurances that the Fed will be cautious in raising interest rates, the Dow Industrials and S&P 500 Index have rebounded within 4% of all-time highs. While a move to all-time highs in these indexes would be encouraging, we'd like to see the Dow Transports reach significant highs before adjusting our cash position. For now, our buy lists have 81% to 82% in stocks.

Violent rally

U.S. stocks have come a long way since Feb. 11, helping the S&P 500 Index record its sharpest six-week advance since 2011. Other risky assets have seen similar surges, with emerging-market currencies and U.S. junk bonds posting their biggest six-week gains in more than six years.

Historically, bear-market rallies have often been short and violent. But rallies in bull markets have tended to look slow compared to the sharpness of the occasional secondary corrections.

As famed Dow Theorist Robert Rhea wrote in 1932, "Bull markets do not begin with violent rallies."

Using that template, investors should view the recent rally with considerable circumspection. On average, U.S. stocks again trade at modest premiums to long-term norms, yet the outlook for corporate profits is grim.

For the March quarter, earnings for the S&P 500 Index are expected to be down 8.7% from the year-earlier period, according to FactSet. While history suggests actual results won't be so bad, earnings are likely to be down for the fourth consecutive quarter — the first such streak since 2009.

For full-year 2016, FactSet's consensus numbers call for S&P 500 Index per-share earnings to rise 2.4% on a 1.4% sales gain. On Dec. 31, the consensus projected full-year growth of 6.7% for per-share profits and 4.2% for sales.

As always, the reaction to quarterly results will be crucial. While today's low expectations for earnings leave room for plenty of upside surprises, the Dow Industrials and S&P 500 Index trade near levels where they have stalled over the past year.


Near-term action could prove telling. A move above the November highs of 17,918.15 in the Industrials and 8,301.80 in the Transports would muddy the outlook under the Dow Theory — and might prompt us to lower our cash position slightly. A move to all-time highs in both averages would put the Dow Theory squarely in the bullish camp, but that would require a rally of more than 15% in the Transports. For now, we intend to watch the averages while holding 81% to 82% of our buy lists in stocks.

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