Momentum Names Clobbered

3/31/2014


Despite worries regarding Federal Reserve policy and the crisis in Ukraine, the Dow Industrials are within 2% of their Dec. 31 all-time high of 16,576.66. A close above that level would corroborate the Dow Transports' move to new highs in early March — and reconfirm the bullish primary trend under the Dow Theory. Without new highs in the Industrials, a breakdown below the Feb. 3 closing lows of 15,372.80 in the Industrials and 7,053.75 in the Transports would represent a bear-market signal.

For now, our three-part game plan is unchanged. Subscribers should watch the averages, maintain a nearly fully invested portfolio, and look for buying and selling opportunities on a stock-by-stock basis. Our buy lists have 94% to 98% in stocks.

Shift toward quality

When newly minted Federal Reserve Chair Janet Yellen said March 19 that the central bank could begin to raise short-term interest rates "around six months" after it ends its bond-buying program, she triggered a sharp reaction in bond yields and stock prices. The bond-buying program is expected to end this fall, meaning short-term rates could be increased in the first half of 2015.

While bond yields have returned close to their March 18 levels, Yellen's comment also exacerbated a shift out of the most speculative and richly valued stocks. The formerly highflying biotechnology group has slumped nearly 10% since March 18, while the Russell 2000 Index of small stocks has dropped more than 3.6%. Meanwhile, the Dow Industrials are roughly unchanged, as blue chips have benefited from a shift toward higher-quality names.

Also benefiting from the shift, at least in relative terms, have been value stocks. The Vanguard Value Index exchange-traded fund, which emphasizes large-company stocks with relatively low price/earnings and other valuation ratios, is roughly unchanged since March 18. The Vanguard Growth Index ETF, which emphasizes shares of faster-growing companies, has dropped 2.7%.

Continued weakness in richly valued groups would not be surprising, especially if investors begin to anticipate an end to the Fed's free-money policy. But if the Fed's move reflects a strengthening U.S. economy, improving profit prospects could counter the downturn in momentum names. A breakout in the Industrials would bode well in that regard, as would a decisive move to new highs in advance-decline lines.

Conclusion

Near-term volatility would not be surprising, but our buy lists are well positioned for a shift toward high-quality stocks with attractive valuations. Steady growers like those listed on page 5 represent good year-ahead picks.


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