Stocks turned lower following Tuesday's elections, with the Dow Jones Industrial Average moving to its lowest level in more than three months. Uncertainties over the looming fiscal cliff, a fresh round of worries concerning economic contraction in the euro zone, and less-than-impressive corporate profits in the third quarter may continue to weigh on stocks in the near term. However, with the last major signal under the Dow Theory bullish, investors should not let headlines chase them away from quality stocks.
Focus on fiscal cliff
Most odds-makers and poll-takers, though conceding a tight race, projected a win for President Obama and a continuation of a divided Congress. So it is hard to call the election results a surprise. In fact, despite some $6 billion spent during the campaign season, the political landscape remains virtually unchanged.
The election did serve as a reminder of the deeply partisan divide on Capitol Hill and across the country. And that divide looms as a major concern as we look toward the fiscal cliff. Without some resolution, massive tax increases and government-spending cuts will occur automatically at the start of next year. Many experts expect the taxes and cuts to send the U.S. economy spiraling into a recession.
To be sure, it is dangerous to ascribe market moves to a single event; and while investors can easily blame election results and their impact on the fiscal cliff, other factors certainly played a role in the market decline. The timing of comments from the euro zone about economic stagnation through 2013 didn't help investment sentiment. Nor did corporations' underwhelming third-quarter profits.
Given today's headline risk, we understand investors who want to dump stocks until the dust settles. The problem with that approach? The dust rarely settles.
We prefer to rely on time-tested guideposts for assessing the market's primary trend. Our favorite is the Dow Theory, which the Forecasts has successfully employed for 66 years.
So far, the bullish primary trend has not shifted. Yes, stocks have pulled back. But the Dow averages — most notably the Transports — have yet to close below important lows. Â
If the election results, fiscal cliff, economic woes in Europe, or continued corporate profit struggles are going to derail this bull market, such a breakdown will show up in new significant lows in the Dow averages, including a close below 4,847.73 in the Transports. At this point, the Forecasts recommends maintaining about 10% to 16% of equity portfolios in a short-term bond fund.