A look at the stock market in mid-year
Taking stock of the market, a top U.S. advisory finds that bad stocks have been beating good stocks — and tells us what to expect now.
We’re not going to say anything about what happened on the stock market yesterday.
It won’t do us much good to look at all that spilled milk, let alone cry over it.
It’s what’s going to happen in the future that counts now. Are we anywhere near a real bull market?
For a mid-year accounting of the markets, we turn to a top U.S. advisory, Dow Theory Forecasts. The outlook is for America, of course, but it gives us a solid reading on North American markets as a whole.
And it also gives us some surprising news as to what kind of stocks have had the best results in the recent market rally.
Finally, it comes with buy recommendations on six superior stocks the advisory likes for the coming months.
The Dow box score
This advisory paints an interesting picture of the market’s progress over the past three months. Bullish sentiment has risen, of course. But this advisory’s chief indicators are still saying, “bear market.”
Here’s the box score for the Dow Jones Industrial Average. From December 31 to March 9 it fell 25 per cent. Then in 13 weeks it rebounded 34 per cent. That’s the fifth-fastest rebound in the Dow’s 112-year history.
The Dow Transportation Average, or Transports, one of the key measuring sticks for this advisory, slumped 39 per cent before shooting back up 59 per cent.
The Russell 2000 Index of small stocks staged the biggest 13-week rally in its history. But it’s only up 5.7 per cent for the year to date.
The worst stocks do best
Meanwhile, the various sectors of the economy have turned upside down. The ones that were sickest before March — financials, autos and auto parts, oilfield equipment and services, metals and mining and hotels — have gained 50 to 60 per cent since then.
The healthier ones — health care, telecom and utilities — have slumped after holding up well when the market tanked.
And here’s the rub. The worst stocks are doing the best.
“Partly because of the shift in group leadership,” says the advisory, “low-quality stocks have rebounded to lead the market’s advance since March. Shares of money-losing companies have handily outperformed those of profitable companies, and those with weak balance sheets have outperformed those with strong balance sheets.”
This may sound whacky, but it’s a whacky market. And it does point to some good news on the road ahead. We’ll get to that in a minute. First, we’ll take a look at market valuations and investor sentiment.
Bullish sentiment
Market valuations plunged before March. On the S&P 1500 Index of large, mid and small cap stocks, stocks traded at 12 times trailing earnings in March. That number subsequently rose to 17.
But that’s still below the 15-year norm of 21 times trailing earnings.
Investor sentiment has risen even more dramatically. The main measure of market fear, the Chicago Board of Exchange (CBOE) Volatility Index, dropped from over 80 in November to 52 in March to 29 in June.
Bullish investment newsletters now outnumber the bears by 48 per cent to 23 per cent. Institutional investors seem more optimistic as well, according to a rather unusual indicator. Analysts predict that operating earnings for the S&P 500 Index will rise 30 per cent in 2010.
So who’s right?
Still in the bearish camp
“While bulls and bears appear sharply divided,” says the advisory, “we see no reason to make an all-or-nothing decision on the stock market. The Dow Theory remains in the bearish camp, as the last confirmed signal was the move to new lows in March.”
Still, both the Industrials and the Transports have rallied sufficiently to establish “a pathway to a bull-market signal.”
The tale may be told shortly. If one average or the other can remain above its March low during a significant market correction (like this one?), it’s a start. If both averages then rebound above the closing highs of the current rally, Dow Theory will in the bullish camp.
“We may reduce our cash position on a market correction,” adds the advisory, “though we are likely to keep a sizeable cash position until we see a bull-market signal.”
Six superior companies
The cash position will depend on the opportunities available with individuals stocks. And here’s the good news promised above. Precisely because “low-quality stocks have led in recent months, many of the best values cam be found among the fundamentally superior companies favored by Dow Theory Forecasts.”
Here are six of them, all Focus List Buys (the advisory’s designation of the best buys for the next 12 months).
Biogen Idec (NASDQ-BIIB) has three major drugs to sustain its momentum over the next 12 months.
Cognizant Technology Solutions (NASDQ-CTSH) supplies business management software, notably a project analysis program called eCockpit.
Comcast (NASDQ-CMCSA) is working to ensure that it gets full value from both cable TV and Internet subscribers.
CVS Caremark (NYSE-CVS) has been doing better with its pharmacy services and retail drug stores than rivals like Walgreen, which took a fearful pounding on the market yesterday.
IBM (NYSE-IBM) is trading at a big discount to the average S&P 500 stock, and expects to hit all of its growth targets for the next year.
Oceaneering International (NYSE-OII) specializes in hard-to-reach places, whether in deep-sea oil finds or outer space. The lengthy contracts for its Remotely Operated Vehicles (ROVs) help it through tough times.
Perhaps this advisory would define a true bull market as one in which good stocks — and those who invest in them — actually get their just desserts. Here’s hoping.
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