Aggressive Selling Premature


Market action has turned a bit choppy, with banks, cyclicals and small-company stocks under pressure. The S&P 500 Index recently edged to new highs amid strength in large tech stocks and defensive areas like consumer staples and utilities. But the Dow Industrials and Dow Transports have not been able to penetrate their March 1 highs, and small-stock indexes are stuck in six-month trading ranges. For now, with the Dow Theory in the bullish camp, our buy lists have 92% to 95% in stocks.

Lopsided performance

Judging by recent sector performance, investors may be discounting a slowdown in the economy or a failure in congressional efforts to pass tax cuts and stimulus spending. Energy, financials, and materials have been the worst-performing sectors since the end of April, while technology, utilities, and consumer staples have been the best.

Indexes limited to value stocks, which tend to perform best when expectations for the economy are improving, have eroded steadily since surging in November and early December. Growth-stock indexes, meanwhile, advanced throughout 2017 before stalling in May.

Similarly, the Russell 2000 and S&P SmallCap 600 indexes are roughly flat so far in 2017, while the large-company S&P 500 is up more than 7.5%. Historically, massive outperformance by large-stock indexes has been a bearish omen. 

Some concern is justified. As we wrote last week, near-term strength in cyclical stocks would be bullish, as it would suggest bond yields have dropped because of mild inflation news — not because the economy is poised to downshift.

However, some perspective is also needed. Value stocks and small stocks surged after the election in November, at least partly because they were more likely to benefit from tax cuts and stimulus spending. With expectations for congressional action diminished, some reversal of the post-election surge is not surprising.

Moreover, while the S&P 500's recent sector performance has been lopsided, the index has not advanced on the back of just a handful of stocks. The S&P 500 advance-decline line, a daily running total of advancing minus declining stocks, hit an all-time high on May 26. For the broad S&P 1500, the advance-decline line reached a fresh high on April 26.


Recent market action has been somewhat discouraging. Still, raising cash aggressively seems premature. If the Industrials or Transports fail to reach new highs, then both averages break below this spring's lows, that would be our cue to raise some cash.

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