Stack on stocks: Compelling fundamentals?

Since the beginning of August, the Dow Jones Industrial Average has traversed 13,823 points on a closing basis, and averaged over 180 points on daily moves. �

Yet last week, the DJIA was just 40 points away from its level back on August 1st. It�s also interesting to note that 85% of the market�s decline from the April 29 peak to the early October bottom occurred over just 13 trading days in late July and early August.�

A major contributing cause to this sell-off was the sudden loss of confidence. It started with the political brinksmanship between the White House and Congress in a showdown over the debt limit deadline. �

The European debt crisis, riots in Greece, and political upheaval in both Greece and Italy that resulted in resignations by their respective Prime Ministers, only added fuel to a fire that had already scorched investor nerves.

The recent ride has been rocky and unsettling, but we think the view ahead appears more calm than what lies in the rearview mirror � except, of course, for one possible speed bump in the road -- the imminent deadline for the debt supercommittee.
The good news is that neither breadth nor leadership is deteriorating ahead of this market.� And in fact, both ingredients have firmed significantly on this latest rally.

Instead of giving an ominous negative divergence (as in October 2007), the Advance-Decline Line is about to break out to the upside even though the S&P 500 has recouped only half its correction loss. �

While positive breadth doesn�t guarantee a bull market, it is an encouraging development and certainly more favorable than the opposite.

Our Negative Leadership Composite, which quickly fell to bear market territory in early August, has started rebounding. �

In examining the raw leadership data, there hasn�t been a single day with increasingly bearish Distribution in this NLC since October 4, the day after the market low.

Fundamentals offers a compelling reason to give the market every benefit of doubt.

The Earnings Yield represents what investors would receive from the S&P 500 stocks if all earnings were paid out as dividends. (Of course, companies don�t do that since a more beneficial effect comes from reinvesting in growth.)

Yet when looking at the past 60 years of the spread between Earnings Yield and T-Bill Yields, you find today�s valuation at one of the best �comparable valuations� since the early 1950s. �

You�ll also discover that most bear markets start when investors can get equivalent returns
from the safety of short-term cash.

Attractive valuation cannot prevent a bear market if negative technical and fundamental conditions prevail.

But this comparison is the most compelling argument against a major bear market like the last two, where losses exceeded 40%. In other words, favorable valuations do tend to limit downside risk.