Bearish trend confirmed

10/6/2008


Amid a widening financial crisis and more signs of weakness in the real economy, the Dow Transports closed below their July low of 4,653.13. The new lows in the Transports confirmed an earlier breakdown in the Dow Industrials, signaling that the market’s primary trend is bearish under the Dow Theory.

Our recommended cash position has been increased to a range of 25% to 35%, meaning 25% to 35% of equity portfolios should be held in a money-market or short-term bond fund. The target weight for each of the 26 stocks on our Buy List is now 2.7%, down from 3.0%. For the Long-Term Buy List, the target weight for each of the 32 stocks is 2.2%, down from 2.5%. With these changes, the Buy List has 70.2% in stocks, versus 70.4% for the Long-Term Buy List.

Bear-market confirmation
With both the Transports and Industrials reaching new lows on Sept. 29, there is little doubt regarding the status of the Dow Theory. When both averages are reaching new lows, the primary trend is bearish and lower stock prices should be expected.

With the benefit of hindsight, our return to the bullish camp in April was a mistake. The April bull-market signal was consistent with Dow Theory principles, and the Transports went on to reach all-time highs in June. But market historians are likely to view the Industrials’ bounce off its January lows as insignificant, meaning the market’s decline over the past year will be viewed as part of a single bear market.

From a Dow Theory perspective, this means the recent breakdown to new lows should be viewed as confirmation of a continuing bear market — not as a new bear-market signal. The difference is somewhat academic, as the Dow Theory cannot forecast the duration or extent of market moves. However, with the Dow Industrials and S&P 500 Index already down more than 23% from all-time highs, history suggests much of the damage has already been done.

Still, subscribers should not be complacent, especially if the market bounces higher in the near term. Surveys and option prices suggest sentiment is near bearish extremes, and the low percentage of NYSE stocks trading above 200-day moving averages suggests stocks are oversold.

Conclusion
While a near-term bounce is possible, subscribers should shift to a more defensive posture. With so many quality growers trading at attractive valuations, we’re comfortable with a cash position near 30%. Depending on the reaction to third-quarter earnings and the market’s ability to hold above the Sept. 29 lows, our cash position could be adjusted in either direction.


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