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Low P/E stocks when indexes hit record

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think_1 June 2014 (Chinavestor) What we said last month turned to be accurate. “Overall trend to continue in May” was given as title for the Newsletter and here we go. Equity markets continued to advance, reaching new record highs by the end of the month.

The Dow Jones Industrial Average (INDEXDJX:.DJI) advanced 1.0% in May and is up 1.7% YTD. The NASDAQ advanced 2.8% for the month and is back in the black for the year. Chinese stocks listed in the US piggybacked US market sentiment and advanced, too. The China ADR Index, compiled by Chinavestor, rose 1.7% in May yet is still in the red for the year.

 

Finally, Chinese stocks in Hong Kong were the most robust on our list of indexes thanks to a 3.7% surge in May. The index however is still in the red for all of 2014.

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Looking more into details, our accurate prediction of further advancing stock market indexes, came against some significant odds.

Just for the record, the Dow Jones Industrial Average stood at 16,717.17 on May 30th, the highest ever close for the index.

The record high came despite news that revised US GDP growth showed a 1.0% drop, the first such contraction since 2011. American industrial production fell 0.6% in April while consumer prices inched up 0.3%. Home builder confidence level hit the lowest level at the same time.

Unemployment numbers were a mixed bag. First time unemployment claims sank by 24,000 to 297,000 however initial unemployment-benefit claims climbed to 326,000. The jobs market is best assessed by looking at jobs creation. This is where it’s obvious that while the jobs situation has been improving, there is still room left to go before we are back to pre-2008 recession levels. See chart on this page for illustration.

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Improvement in home builder confidence for the month coincides with the FED’s prediction of continuing economic improvement till the end of 2014.

Assuming no major policy change, we expect equity markets and indexes to continue an upward trend for the summer.

An overall strong market sentiment is a positive thing but is not a bulletproof recipe for investors. Look at how much the best and worst five components of the Dow have deviated for the first five months of 2014.

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Alcoa Inc. (NYSE:AA) surged 28.8% compared to a 7.7% decline from Bank of America (NYSE:BAC).

Besides these extremes, there has been quite a discrepancy among the 30 Dow components for the first five months of the year.

We believe that sector rotation is responsible for most of the gains and losses.

Alcoa Inc. (NYSE:AA) has been underperforming the Dow since the 2008 meltdown and it was time for this resource player to shine. Good news is that despite a stellar 2014 performance, Alcoa is still well below the Dow for the last five years. Alcoa Inc. (NYSE:AA) is up 49.8% since May 2009 vs the Dow’s 102.8% recovery.

The same line of thinking applies for Cisco Systems (NASDAQ:CSCO) and Hewlett-Packard (NYSE:HPQ). These stocks fell hard in 2008 and the subsequent years, missing out on an early recovery. As a result, despite a 2014 strong showing, both CSCO and HPQ continue to lag the Dow. This implies more upside is possible for these “dogs of the Dow” for the rest of 2014.

The financial sector was hit the hardest in 2008-2011 for a good reason. No wonder, some of its components fell a lot harder than they should have. At least this is what the market was thinking when bottom fishers bought everything from the sector starting in 2012. Bank of America (NYSE:BAC), JP Morgan Chase (NYSE:JPM) and the likes far outperformed the Dow in 2012-2013 but that advance is now coming to an end. To be precise, Bank of America (NYSE:BAC) advanced 95% in 2012-2013 while JP Morgan Chase (NYSE:JPM) recovered 55% during those years. The Dow Jones Industrial Average (INDEXDJX:.DJI) advanced 28.7% at the same time. In other words, BAC recovered over three times as much and JPM recovered over twice as much as the Dow in 2012-2013. Little surprise that both financial stocks succumbed to profit taking in 2014.

Besides sector rotation, earnings drive stock prices. Some argue to what degree they do, but it is certain that they contribute. This is a lot more sensitive issue because earnings can make it or break it, when it comes to stock price performance.

Second part of Newsletter continues at WallStreetNews.today



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