IQ Trends: Stocks, Value, Hope & Risk

03/21/2017 2:50 am EST

Focus: STOCKS

Kelley Wright

Managing Editor, Investment Quality Trends

Stocks offer the greatest values in the depths of a bear market because their prices are below the intrinsic value of the companies, asserts dividend and value investing expert Kelley Wright, editor of Investment Quality Trends.

In more simple terms, a bear market is when you find the greatest number of Undervalued stocks. When the bear market begins to wane and a new bull market begins to emerge, stock prices begin to rise to more realistically reflect the intrinsic values of the companies.

the companies. Once again, in more simple terms, it is in an aging bull market when you find the greatest number of Overvalued stocks.

The above, in a nutshell, is what we learned from Benjamin Graham. Shelby Davis and Warren Buffett figured it out, as did our own founder Geraldine Weiss.

This is why all three concentrated on quality and values, and IQ Trends continues to do so today. One need not be a market maven to conclude that today we are decidedly in a bull market.

What stage of the bull market remains to be seen, but one of the technical signposts that the primary trend is pointing north is a simple comparison of the market opening with the market closing.

In classic bull market fashion, we have seen the market open to the downside only to reverse course and close in positive territory.

At some point a pattern will emerge where the market opens to the upside only to reverse course and close in negative territory. When enough of those types of days are strung together nearby technical areas of support will be violated.

Typically, the market will rally around a technical area of support in an attempt to re-establish the uptrend. If that rally fails selling will typically continue to the next level of support.

This pattern will persist until the uptrend is re-established or long-trend support is violated. Once long-term support is violated then the primary trend is down.

Over the course of our publishing history we have developed our own “signposts,” or technical indicators that provide us insight into the degree of value present or lacking in our universe of Select Blue Chips, which we can then apply to an analysis of the broader market.

First is the percentage of Select Blue Chips in the Undervalued category. Historically 17% or less has been coincident with major market tops. This is not to say that a reading of 17% or less guarantees the market is at a major top, but that conditions exist that have been present at past market tops.

Second is if the percentage of Overvalued stocks is twice that of Undervalued stocks. Once again, this is an indicator of existing conditions similar to that of prior tops.

Lastly is the dividend yield of the Dow Jones Industrial Average. Currently the Overvalued yield of the Dow is 2.0%. Once the yield falls within 10% of 2.0%, which would be 2.20% or lower, it would be statistically within the 10% margin of error of the historically repetitive Overvalued area.

Note that the current dividend yield of the Dow is 2.32%, 12 basis points from the 2.20% level. Also, note that the theoretical upside is 16%, versus the theoretical downside of 42%.

Our Blue-Chip Trend Verifier displays the percentage of Select Blue Chips in their respective categories. Currently, the Undervalued category is below 17%, and the percentage of Overvalued stocks is on the cusp of being double those of the Undervalued stocks.

A long-held Wall Street axiom is that the market climbs a Wall of Worry and slides down a Slope of Hope. In this era of opposites, I would suggest that the market is climbing a Slope of Hope. Hope for tax cuts, hope for deregulation, hope for infrastructure spending, etc.

One has to wonder if another Wall Street axiom, “Buy the rumor and sell the news,” will come into play if all this hope comes to fruition. As for the data and signposts above, what they are telling us is that while the primary trend may be up, conditions exist that could spell danger.

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