New Highs Needed

2/17/2014


In many ways, this year's market pullback has been a fairly classic bull-market correction, with stocks retreating after a feverish advance and investor sentiment cooling from overheated levels. Of course, bull-market corrections are the kind that end with new highs in the averages, so the real test will be the recent all-time highs of 16,576.66 in the Dow Industrials and 7,569.89 in the Dow Transports. With closes in both averages above those points, the bullish primary trend would be reconfirmed under the Dow Theory. For now, we're holding 89% to 92% of our buy lists in stocks and looking for opportunities one name at a time.

Typical declines

From Dec. 31 to Feb. 3, the Dow Industrials slumped nearly 1,204 points, or 7.3%, retracing 67% of the October-to-December advance. The Dow Transports dropped 516 points, or 6.8%, from Jan. 23 to Feb. 3, retracing 46% of the October-to-January advance. The S&P 500 Index lost 5.8% from its Jan. 15 high to Feb. 3, retracing 55% of its advance since Oct. 8.

Those are fairly typical bull-market declines. And the pullback had a fairly typical impact on investor sentiment, with the percentage of bullish investment newsletters dropping below 42% — down from a six-year high of nearly 62% on Dec. 31, according to Investors Intelligence. The American Association of Individual Investors survey puts the percentage of bulls below 28%, down from 55% on Dec. 26. Outflows from U.S. equity funds hit an all-time high for the week ended Feb. 5, according to Lipper.

Considering the severity of the market decline and its impact on investor psychology, there is little doubt that the pullback from the recent all-time highs should be viewed as a significant correction under the Dow Theory. The question is whether the rebounds from the Feb. 3 lows of 15,372.80 in the Industrials and 7,053.75 in the Transports qualify as meaningful retests of the highs. We're inclined to answer yes, though the bounce in the Transports has been fairly skimpy by historical standards.

The Dow Theory considers only the action of the Industrials and the Transports. However, we consider all evidence in evaluating whether the market's primary trend is bullish or bearish. We'd like to see the S&P 500 Index rally above its Jan. 15 all-time high of 1,848.38. We'd like to see new highs in the S&P 1500 advance-decline line, a running daily total of advancing minus declining stocks in the broad S&P 1500 Index.

Our advice

A rebound above the all-time highs would be bullish, while a breakdown below the Feb. 3 lows would be discouraging. Among Focus List selections, the five reviewed in Focus Favorites represent our current favorites for new buying.


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