Maintain Bullish Posture


Since surging to all-time highs on March 1, the averages have been moving mostly sideways, with strong economic news countered by worries that corporate tax reform will falter. Bond yields have moved to the high end of a four-month range, helping bank stocks but weighing on utility and telecom names.

While a market pullback would not surprise us, we think a nearly fully invested posture remains appropriate. The Dow Theory is squarely in the bullish camp, and we are still finding reasonably valued stocks with solid profit-growth outlooks. Our Focus List and Buy List have 100% in stocks, while our Long-Term Buy List has 94%.

Positive momentum

Stocks moved higher in both January and February, which history suggests bodes well for the remainder of the year. Since 1950, the S&P 500 Index has advanced in both January and February 26 times. In 24 of those 26 instances, stocks moved higher in the remaining 10 months of the year.

Putting too much faith in such historical patterns is a mistake, but the market clearly has momentum on its side. In fact, the main risk may spring from an excess of positive momentum, either for the stock market or the economy. 

While sentiment among individual investors remains subdued, mutual-fund inflows have surged from year-earlier levels. Investment newsletters are unusually bullish. Valuations are expensive, with the S&P 500 Index's forward P/E of 18 about 20% above the long-term norm.

To help put bull markets in perspective, Dow Theory adherents like to divide them into three phases. In the first, stocks rebound as investors regain confidence that business conditions will eventually improve. In the second, stocks advance on improving earnings. In the third, speculation is rampant.

With earnings growing again and the outlook for the global economy improving, it seems premature to conclude we've reached the third phase of this bull market. But a surge in bullishness among individuals would be worrisome.

Also potentially worrisome would be a surge in economic momentum that brings inflationary pressures — and forces the Federal Reserve to boost interest rates. Current short-term rates remain quite low relative to inflation, so an unexpected jump in inflation could bring sharply higher interest rates.


A bullish posture remains appropriate, but we'll be watching for signs that investor sentiment has become too exuberant or that inflation pressures are heating up. Attractive names include Celgene ($123; CELG) and Owens Corning ($60; OC).

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