Broad Market At New Highs

3/10/2014


Shaking off a Russian incursion into Ukraine and mixed economic data, the large-company S&P 500 Index and small-company Russell 2000 Index reached fresh all-time highs. So did the all-company Wilshire 5000 Index, the S&P Midcap 400 Index, the Morgan Stanley Cyclical Index, and advance-decline lines for the broad market.

Yet the Dow Industrials and Dow Transports, the only two averages that figure in textbook Dow Theory analysis, have stubbornly refused to confirm. A reconfirmation of the bullish primary trend requires closes above 16,576.66 in the Industrials and 7,569.89 in the Transports. Without closes above those levels, a breakdown below the respective Feb. 3 lows of 15,372.80 and 7,053.75 would represent a bear-market signal under the Dow Theory.

Given the strength in the broad market, some may question whether it makes sense to put much stock in the action of the Industrials (a price-weighted index of 30 blue chips) or the Transports (a price-weighted index of 20 railroad, trucking, airline, airfreight, and other shipping-related stocks). We think it does, for at least three reasons:

➤ A system needs rules, and the Dow Theory has compiled an impressive record of keeping investors on the right side of the primary trend over the past century. Partly because of our use of the Dow Theory, Dow Theory Forecasts ranks among a select group of newsletters that have outperformed the Wilshire 5000 and S&P 500 on both an absolute and risk-adjusted basis over the past 10 and 15 years, according to the Hulbert Financial Digest.

➤ The members of the Industrials and Transports are among the largest, most globally diversified, and most closely scrutinized companies on the planet. If the U.S. market generals are not participating in an advance, it may signal something about the state of the world.

➤ From a trading perspective, watching for confirmation from the Industrials and Transports does not have a big opportunity cost. The last major signal under the Dow Theory was a bull-market reconfirmation, and our portfolios are already nearly fully invested. If the bull market is truly intact, the Industrials and Transports will advance the 1% to 2% needed to reach new highs.

Our advice

The Dow Theory does not always work, and we don't set our stock-market exposure solely on the state of the Dow Theory. The broad-based nature of the market's advance is encouraging. Also, we continue to see opportunities among reasonably valued growers. Our buy lists have 94% to 98% in stocks. Especially timely picks include Alaska Air ($89; ALK) and Skyworks Solutions ($37; SWKS). Both earn Overall Quadrix scores of 99, with Value, Performance, and Earnings Estimates scores above 65.


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