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business newsEuropean Euphoria Brings on Dow Jones Industrials "Crescendo"
By
Jeff Saut
Oct 31, 2011 12:30 pm
While pundits were contemplating the end of financial life as we know it, the S&P 500 looks to have posted its biggest monthly gain since October 1974.
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Gotcha’ Nouriel Roubini . . . Gotcha’ Harry Dent . . . Gotcha’ Robert Prechter, for while such pundits were contemplating the end of financial life as we know it, the S&P 500 (SPX) looks to have posted its biggest monthly gain since October 1974 (~16%) and likely the tenth best month since 1928. Verily, from the October 4 intraday low (1074.77) into last Thursday’s intraday high (1292.66), the S&P 500 has gained ~20.3%, with many investment vehicles doing much better than that. The culprits for the massive move have been better than estimated economic reports (which have taken recession fears off of the table), a kiss and make up from Merkel and Sarkozy, and great third-quarter earnings reports. In fact, as of this morning, the 323 companies in the S&P 500 that have reported thus far have showed year-over-year earnings up 24.3%, with revenues better by 12.8%. That’s a company earnings “beat rate” of 64.7% combined with a revenue “beat rate” of 63%. The result has left the SPX’s consensus 2012 earnings estimate nestled around $109, implying a forward P/E ratio of 11.7x.
Given such metrics I’ll say it again, “To an underinvested portfolio manager, the current news environment is a nightmare.” Yet surprisingly, the world remains profoundly underinvested in US stocks. Underinvested indeed, for as repeatedly stated, I could not find one European PM that had more than a 15% weighting in US equities despite the fact their benchmark index has a ~43% weighting.
Even here in this country, most endowment funds have less than a 10% weighting in US stocks. Ladies and gentlemen, there is no way an endowment fund can achieve its mandated return of 6% to 9% per year using 2.3%-yielding 10-year Treasuries. Manifestly, all we need is for PMs to realize this, and decide it’s time to reallocate money by switching out of fixed income and into equities, for the S&P 500 to do better than most expect. To be sure, that’s what we expect, which should cause professional money to chase stocks higher driven by performance anxiety. Therefore, we continue to favor the strategy of buying “dips.”
That said, the upside skein has left the markets overbought in the short-term with 93.6% of the SPX’s stocks above their 50-day moving averages (DMAs). Back at the market lows that figure was only 4%. Additionally, the McClellan Oscillator remains about as overbought as it ever gets. Moreover, the “buying stampede” now stands at session 19. Readers of these missives know such stampedes tend to run 17 – 25 sessions, with only one- to three-session pauses and/or pullbacks, before they exhaust themselves on the upside. Therefore, with the major averages up against overhead resistance levels, as well as trading around their 200-DMAs, it would not be surprising to see a longer pause (or pullback) than the one- to three-session pattern we have been experiencing since the 10/4/11 lows. To us, the real question is – will the SPX get a pullback to the often mentioned pivot point of 1217, or will any pullback be short and shallow? Well, by our work the equity markets still have a lot of internal energy to power their way higher, so our sense is the S&P 500 will keep pushing higher in the months ahead with only shallow pullbacks and sideways pauses along the way.
If that strategy proves correct, the question then becomes what to buy. In addition to the names so often mentioned in these reports, we turn to the invaluable Bespoke Investment organization and their “triple play” screen for a “shopping list.” Bespoke defines “triple plays” as “companies that have recently beaten their earnings estimates, beaten revenue estimates, and have raised forward earning guidance. Typically less than 5% of companies reporting during any given earnings season will report triple plays, which makes them extremely rare.”
Names in that group, which have recently reported such metrics and are followed by Raymond James’ fundamental analysts with a favorable rating, include Abbott Labs (ABT); Advanced Micro (AMD); Chubb Corporation (CB); Citrix Systems (CTXS); Extra Space Storage (EXR); Intel (INTC); McKesson (MCK); Panera Bread (PNRA); Select Comfort (SCSS); Tractor Supply (TSCO); and Vocus (VOCS). To further refine this list, we used our proprietary trading algorithms and found these names to be potentially the timeliest: Abbott, Chubb, Extra Space, Intel, Panera Bread, Select Comfort, and Tractor Supply.
As for the plethora of emails I received about, “Did we finally get a Dow Theory “buy signal?” It does appear that a “buy signal” has been registered with both the D-J Industrials and the D-J Transports rising above their respective recent reaction highs.
That upside breakout came after both indices made new closing reaction lows on October 3, 2011; hence, the “buy signal” seems valid. This means the Dow Theory “sell signal” of August 4, 2011 should prove to be a false signal, as we have repeatedly opined for nearly two months. Of course, the longest keeper of Dow Theory, namely Richard Russell, has stated that there never was a sell-signal since he is using the July 2010 reaction lows of 9686.48 and 3906.23 to get a sell-signal, while I used this year’s closing lows of March 16. If one follows Richard’s method it implies that he probably didn’t get a Dow Theory “buy signal” either since he likely would need both averages to travel above their respective 2011 reaction highs of 12810.54 and 5618.25. Recall, it was an upside nonconfirmation from the Industrials, which failed to confirm the Tranny’s new all-time high of July 7, 2011 at 5618.25, that lead to the ensuing ~17% decline for the senior index. Let’s hope it doesn’t play that way again.
The call for this week: If past is prelude, something dynamic should occur within the markets during my travels. My guess is that it will be some sort of trading top given all the aforementioned metrics. However, despite the near-term overbought condition, the stock market has staged a strong upside breakout above the now two-month trading range, as well as above the Dow’s 200-DMA (11973.09). This is remarkably similar to what happened in the October 1978 and October 1979 analogues. The upside skein from the October 4 lows has also been accompanied by four 90% Upside Days and two consecutive 80% Upside Days. The breakout has been confirmed by the advance in the Cumulative Net Points and the Cumulative Net Volume indexes, suggesting the rally is sustainable. Given this, we continue to favor the strategy of buying “dips” rather than selling strength.
No positions in stocks mentioned.
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