Earnings Lift Broad Market


Boosted by solid March-quarter results and optimism regarding corporate tax cuts, the Dow Industrials have rallied within 1% of all-time highs. Continued strength during earnings season would be encouraging. But new highs will have more meaning if confirmed by the Dow Transports, which have stalled amid some downbeat results from trucking and logistics providers.

With closes above the March 1 all-time highs of 21,115.55 in the Industrials and 9,593.95 in the Transports, the Dow Theory would be reconfirmed as bullish. A failure to reach new highs in either average would indicate some uncertainty regarding the market's primary trend. For now, our buy lists remain nearly fully invested, with at least 94% in stocks.

Both averages must confirm

Does it make sense to attach so much importance to the Transports, a 20-stock average of airline, airfreight, railroad, and trucking companies?

For Dow Theory adherents, the answer is yes. William Hamilton, one of the theory's founders, wrote in 1928, "Half an indication is not necessarily better than no indication at all. The two averages must confirm each other."

Still, that does not mean the averages must reach new highs at the same time, or that a failure to reach new highs would be a sell signal. For a bear-market signal under the Dow Theory, one or both averages must fail to reach new highs, then both averages must move below significant lows.

For the Transports, the April 13 closing low of 8,874.56 seems plainly significant, as it followed a nearly six-week correction of more than 7%. But the low point in the Industrials since March 1 — 20,404.49 on April 19 — represented a mere 3.5% decline and retraced only 22% of the November-to-March advance. Typically, significant corrections retrace one-third to two-thirds of the preceding advance.

Without confirmed new highs, breakdowns below 8,874.56 and 20,404.49 would likely be reason enough for us to raise some cash. But we're not convinced such breakdowns would represent a bear-market signal. And we don't think it makes sense to raise cash aggressively at this point, partly because the broad market has reacted positively to March-quarter results.

The S&P 1500 advance-decline reached new highs in late April, as did the Nasdaq Composite and Russell 2000 Index of small stocks. With results in from more than one-fourth of S&P 500 components, about 78% have exceeded consensus profit estimates, according to Thomson Reuters. That is well above the long-term norm of 64%. Earnings for the S&P 500 Index are now expected to be up 11.4%, the best year-to-year increase since mid-2011.

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