Bond-Like Stocks Slump


The Dow Jones Industrial Average and S&P 500 Index, down slightly from their mid-August peaks, have made no progress since mid-July. Federal Reserve officials have sounded a bit more hawkish lately, signaling that an increase in short-term interest rates could come as soon as mid-September.

While yields on long-term Treasury bonds have moved little, prices for some formerly stalwart bond-like stocks have turned lower. Utilities, telecom, and consumer staples have been the worst-performing major sectors so far in the third quarter — a sharp reversal from the first half of the year.

Financials and technology have led the pack so far this quarter, and we view the rotation toward more growth-oriented stocks as bullish. But we'd like to see a more decisive breakout in the broad market, along with confirmation from the Dow Transports.

A close in the Transports above the April high of 8,109.19 would suggest the average is trending higher — and move the Dow Theory into the bullish camp. For now, we intend to watch the averages while holding some extra cash on the sidelines. Our buy lists have about 81% in stocks.

Encouraging rotation

Historically, September has been a bad month for stocks. On average over the past 100 years, the Dow Jones Industrial Average has lost nearly 1% during September, according to Bespoke Investment Group. No other month has averaged a decline.

The Dow has also has averaged a decline for September over the past 20 and 50 years, says Bespoke, though it tends to fare better in Septembers when it enters the month with a year-to-date gain. Still, bears argue this September could be a time of reckoning, with some predicting that Federal Reserve tightening will prove too much for an overvalued stock market with declining earnings.

Some pickup in market volatility seems likely, and 5% to 10% pullbacks are impossible to predict with any precision. But we're not convinced gradual tightening from the Fed will be enough to trigger a bear market — if corporate earnings growth revives.

On that front, recent results provide some grounds for optimism. The median company in the broad S&P 1500 Index delivered year-to-year sales growth of 4.5% in its most recent quarter, up from less than 2% earlier this year. Median growth in per share earnings is 5.6%, up from less than 1%.

Also encouraging is the recent rotation out of bond-like stocks into more growth-sensitive names, but we'd like to see the Transports and other cyclicals make a decisive move higher. We'd like to see the Transports confirm the bull market by finally surpassing 8,109.19.

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