Broad Market In Trading Range
Are stocks trending higher?
Dow Theorists want to know the answer to that question because they believe the majority money opinion is usually right. When the market's primary trend is bullish, underlying company values are probably rising — and owning stocks is probably a good idea.
The Dow Theory considers only the action of the Dow Industrials and Dow Transports, defining a bull market as one that lifts both averages to significant highs. For example, a rally that lifts the Industrials above 13,279.32 and the Transports above 5,368.93 would reconfirm the primary trend as bullish. Without new highs in both averages, a breakdown below this year's respective lows of 12,101.46 and 4,847.73 would signal that the primary trend is bearish.
But the Industrials and Transports have been stuck in trading ranges this year, and nothing says the Dow Theory must be used to the exclusion of all considerations. Among the most frequently used tools for determining the broad market's trend is the advance-decline line, which represents a running daily total of advancing stocks minus declining stocks.
Some bulls, citing recent new highs in the New York Stock Exchange advance-decline line, argue the broad market is clearly trending higher. But the NYSE advance-decline line includes bond funds, preferred stocks, and other securities sensitive to interest rates, and sharply lower bond yields have lifted such securities broadly higher. As a result, the NYSE advance-decline line is painting a misleading picture.
For a more accurate read on the broad market, we create advance-decline lines from stocks in the large-cap S&P 500 and all-cap S&P 1500 indexes. Advance-decline lines limited to stocks from these indexes have not reached new highs since spring. Similarly, the Value Line Arithmetic Index, an equal-weighted measure of more than 1,600 stocks, has been unable to surpass the high reached in March.
Encouragingly, the S&P 500 advance-decline line is within striking distance of new highs, just like the S&P 500 Index. A gain of less than 1% would lift the S&P 500 Index above its April high of 1,419.04, putting the benchmark at four-year highs.
With the broad market and the major averages stuck in trading ranges, we are maintaining a wait-and-see posture. As a partial hedge, our buy lists have 10% to 15% in a short-term bond fund. With the remaining 85% to 90%, we are emphasizing quality stocks with operating momentum and attractive valuations. Especially promising names include Express Scripts ($62; ESRX), Google ($677; GOOG), and Wells Fargo ($34; WFC).