As Oil Jumps, Market Slumps
Stocks have retreated, with tensions in Syria pushing oil prices to their highest level this year. For both duration and extent, the corrections in the Dow Industrials and Dow Transports from the all-time highs reached in early August now clearly qualify as significant.
If the next significant rally pushes the Industrials above 15,658.36 and the Transports above 6,670.06, the Dow Theory will remain in the bullish camp. If the averages rally but one or both fail to surpass August highs, the stage will be set for a bear-market signal. For now, our buy lists have 94% to 95% in stocks.
Major bull markets tend to have three phases. In the first, stocks bounce as investor confidence rebounds from depressed levels. In the second, stocks respond to improving corporate earnings and dividends. In the third, speculation is rampant and stocks advance on hopes and expectations.
Some bears argue this speculative third phase ended in early August, as rising price/earnings ratios accounted for nearly all this year's advance. In fact, the past 12 months have seen the sharpest increase in the P/E ratio of the S&P 500 Index since the late 1990s, according to Bloomberg.
Bulls argue that valuations are still well below prior bull-market peaks, that earnings and dividends are still rising, and that sentiment is far from euphoric. Indeed, the percentage of bullish investment newsletters has dropped to a nine-month low of 38.1%, according to Investors Intelligence.
We tend to side with the bulls, partly because the market's primary trend was unequivocally confirmed as bullish in early August. Not only did the Industrials and Transports reach all-time highs, so did broad indexes like the S&P 1500. Equal-weighted measures, including equity advance-decline lines, also reached new highs.
Some argue the inability of the New York Stock Exchange advance-decline line to stage a decisive breakout since May represents a worrisome divergence. But only about 82% of the issues traded on the NYSE are stocks, with most of the rest bond funds. Advance-decline lines for stocks in the S&P SmallCap 600, S&P Midcap 400, and S&P 500 indexes peaked well above previous highs in late July or early August.
A failed attempt at new highs, followed by a breakdown below the lows established in the current correction, would suggest the primary trend has turned bearish. But the weight of the evidence still points to higher stock prices.