Both Averages Must Confirm

8/27/2012


The Dow Industrials and S&P 500 Index are flirting with four-year highs. But neither average has managed to surpass its 2012 high on a closing basis, and the Dow Transports remain more than 3% from this year’s closing high of 5,368.93. Some related questions:

What is the state of the Dow Theory? With closes above 13,279.32 in the Industrials and 5,368.93 in the Transports, the primary trend would be reconfirmed as bullish — and the respective June closing lows of 12,101.46 and 4,847.73 would no longer be relevant. Without new highs in both averages, a breakdown below the June lows would represent a bear-market signal.

What should I do with my portfolio? For now, hold 10% to 15% of your equity portfolio in a short-term bond fund. With a bull-market reconfirmation, we will be looking to lift our exposure to stocks. With a bear-market signal, we will reduce our stock-market exposure to 75% immediately — and our hotline will be updated with instructions.

Does it really make sense to look at past highs so precisely? Yes, a system needs precise rules, and the Dow Theory’s use of significant highs and lows has stood the test of time. Also, significant highs represent former peaks in bullish enthusiasm. If those highs are surpassed, it would suggest actual company values are trending higher.


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