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Last week, I discussed whether we are seeing the start of a recovery or just a bear market rally. It's still too early to say if a bottom has been firmly established. However, if we look out over 12 months, U.S. equities seem like they could be the best game in town. There are several reasons why. Relative valuation - The S&P 500 currently trades with an earnings yield of about 7%. Conversely, 10-year treasury bonds are yielding about 3.85%. This suggests stocks are more attractive on a valuation basis than long-term treasuries. Diminished downside risk - During the period of Oct 2007 to July 2008, the Dow fell by about 23%. Such a decline is close to what typical bear markets look like. (Research by Jack Schannep, of TheDowTheory.com, finds that 80% of bear markets have declines of 24% or more.) Although the ongoing credit and economic conditions might cause some more weakness over the short-term, most of the damage has likely already occurred. Lack of attractive alternatives - The next move by the Fed will be to raise rates, which is bearish for long-term treasuries. The Japanese and European Union economies contracted in the second quarter. Eastern Europe has to contend with a militarily aggressive Russia and Brazil is losing favor because of falling commodities prices. If the U.S. is closer to a recovery than other major economies, than domestic equities should outperform their international peers. Keep in mind that I'm talking about relative returns. My expectation is that the U.S. markets will remain choppy over the next few months. This said, the outlook for the next 12-18 months does appear brighter, especially since stocks have a tendency to rebound before the economy does. As I said last week, when the market finally does make a successful recovery, there won't be much foreshadowing. Market Overview The upward move that started in mid-July remains in place. Tech stocks have made a nice move lately, but do look a bit overbought. Dow theorists look to the Dow transports as an indicator for where the market is headed. I don't follow Dow Theory, but I do occasionally look at the chart of the ETF that tracks the Dow Transports to see what it's doing. The two-year chart shows the trends better than the one-year chart, but the transports are not providing a clear signal for market direction. Focus List Updates CF Industries (CF) is continuing its volatile ways. The odd thing is that the stock's forward P/E multiple has actually declined throughout the year. All signs point to continued strong demand for fertilizer and earnings estimates continue to be revised upwards, so we're keeping the stock in the portfolio. But, I do expect more price swings in the stock. Columbus McKinnion (CMCO) was added to the Focus List. The company manufactures hoists, cranes, conveyors and related products. It was one of many industrial product companies to report good second-quarter results and raise guidance. Plus, it has a low valuation. Petrobras (PBR) was sold from both the Focus List and the Timely Buys List this week. We expected some near-term weakness, but overall weakness in Brazilian stocks combined with falling oil prices caused a dramatic drop. I continue to like the company's prospects, but our timing was clearly wrong on PBR. Our policy is to remove a stock from the Timely Buys List during the middle of the week if the stock is also being sold from the Focus List. This is what happened with PBR this week.
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Charles Rotblut is the Vice President of Web Content for Zacks Investment Research and the Senior Market Analyst for Zacks.com. He oversees the editorial staff, manages the market-beating Focus List, Timely Buys and Top 10 portfolios, and plays an instrumental role in the development of new products. For more information, visit www.zacks.com
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