Two Reasons Stocks May Be Cheap

04/07/2008 12:00 am EST

Focus: MARKETS

Charles Carlson

Editor, DRIP Investor

Charles Carlson, editor of the DRIP Investor, says a couple of his favorite indicators are pointing to higher stock prices ahead.

It is not easy to find anything positive about the current market and economic climates. That's why what I'm about to tell you may sound, well, crazy: there are reasons for optimism.

First, against the backdrop of a sluggish economy and record high oil prices, it is significant that the Dow Jones Transportation Average has remained stubbornly above its January low. In fact, for the year to date, the Dow Transports are in the black.

Why, you are probably asking, should investors care about the Dow Transports?

Two reasons. First, the Dow Jones Transportation Average is perhaps the most economically sensitive of all the major market indexes. Thus, its resilience in the face of an economic slowdown and high energy prices is encouraging. Second, the ability, at least thus far, of the Transports to remain above their January lows of 4140.29 has created divergence between the Transports and the Dow Jones Industrial Average.

Divergence between the Dow Industrials and Transports oftentimes is a precursor to a change in the primary trend. Thus, should the Transports continue to remain above their January lows, it would be an important step toward moving the market's primary trend back to the bullish camp.

Another reason to be optimistic is that, based on one of my favorite indicators, stocks are as cheap as they have been in a decade.

The Intermediate Potential Risk Indicator looks at the percentage of stocks on the New York Stock Exchange that trade above their 200-day moving average. History shows that when lots of stocks are trading above their 200-day moving average, stocks are richly valued and poised for a tumble. Conversely, when few stocks are trading above their 200-day moving average, stocks are cheap and offer good rebound potential.

Recently, the percentage of stocks on the NYSE trading above their 200-day moving average-the lowest since 1998.

To be sure, history has shown that stocks can stay cheap for rather lengthy periods of time. Thus, while investors who buy stocks now may not see that buying instantly rewarded, our research indicates that your willingness to buy now should be rewarded in a big way down the road.

Sure, if you want to play a little defense, holding some money on the sidelines is fine. But you will never call the exact bottom of the market. The best you can do is to pick your spots when you think stocks are cheap.

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