Smart Investing Daily – The “Inflate-a-Rally”

It All Comes Back to Commodities

Caterpillar or CAT tractor, as we traders like to call it, has led the Dow in its most recent charge to the upside. Without CAT’s huge upside moves over the past couple of months, the Dow Jones would NOT be where it is today. CAT’s rally has been driven by the ongoing weakness in the dollar and in turn the contrary strength in commodities.

It’s not just CAT that gets a boost from Helicopter Ben’s loose monetary and weak dollar policies, but basically any company with substantial operations in foreign countries whose currency is stronger than ours. Companies such as McDonald’s (MCD), IBM, Coca-Cola (KO), Boeing (BA), GE, Intel (INTC), 3M (MMM) and PepsiCo (PEP) also fall into that category.

Coincidentally, those companies alone account for one-third of all the companies that comprise the Dow Jones. (Most of the others also have foreign exposure, of course.) But even those nine companies, excluding all others, would have an effect greater than 60% of the index because of their high weightings.

It is important to remember that for companies to take full advantage of a weak dollar, they must produce their goods here and ship them to countries with stronger currencies. Also of note is the fact that they should be reporting in U.S. dollars.

So realize that if the dollar makes a sharp trend reversal (which I don’t think will happen soon), many of these stocks could have the wind taken quickly out of their sails and experience a 180-degree shift in direction.

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Why I’m Taking the Cautious Approach

A couple of weeks ago, I wrote about the markets still being relatively cheap, and luckily for me, my thesis has been correct. Of course, there are a multitude of inputs and variables I use to determine relative value. One of the most important basic fundamental data points I look at is the price/earnings ratio of the S&P 500, both the trailing history as well as the projections.

As it stands now, only about 12 companies in the S&P have reported their earnings. All of them are showing positive growth (bottom line) compared to last year, with the strongest coming from the materials sector (no surprise there).

It still looks good from a value perspective with the S&P’s collective trailing P/E multiple at 15.42 and the forward just below 14. As I said before, this minimal gap tells me that the expectations for growth are moderate, not super high. When you have higher expectations, you have a greater chance for disappointment; watch the P/E ratios of the individual names you may invest in.