Nowhere To Hide

2/23/2009


Stocks have slumped broadly, reflecting worries about the financial sector and a deepening global recession. The Dow Industrials closed within a few points of the Nov. 20 low of 7,552.29, nearly confirming a fresh breakdown to new lows in the Dow Transports. With the Dow Theory in the bearish camp, a defensive posture remains appropriate. Of the portion of your portfolio committed to equities for the long haul, hold 30% to 40% in a short-term bond fund as a defensive hedge.

Bearish backdrop
Investors have no shortage of reasons to worry. Near the top of the list are fears that many U.S. and foreign banks are insolvent; that government meddling in the economy is making things worse; that the global economy is headed toward a long and painful recession; and that corporate earnings and investment will remain depressed as companies and consumers pay down debt amassed over the last two decades.

Against this bearish backdrop, bulls saw a couple of reasons for optimism in the stock market’s action — until recently. First, despite abysmal December-quarter results and another huge decline in financial stocks, the major U.S. averages had avoided a breakdown below their November lows. However, the Dow Industrials have moved within a few points of 7,552.29, their lowest level since 2003. Broader indexes like the Dow Jones Wilshire 5000 and S&P 500 have managed to avoid new lows, though both are within 7% of their November lows.

Second, performance between different sectors of the U.S. market had begun to diverge this year, suggesting investors had started to refocus on company and sector fundamentals rather than exiting the stock market entirely. However, all 10 sectors of the S&P 500 have slumped in the market’s most recent slide, pushing all 10 into negative territory for the year.

Among the 134 industry groups in the S&P 500, fewer than 30 have year-to-date gains. Only one of the 20 financial groups has advanced, and none of 18 groups in the industrial sector has advanced. In the traditionally defensive sector of consumer staples, only one of the 12 groups has gained, partly because of weakness in overseas economies.

Conclusion
A close below 7,552.29 in the Industrials would reconfirm the primary bearish trend under the Dow Theory. A bear-market confirmation would imply that a return to the bullish camp is unlikely anytime soon. Our Focus List and Buy List have 32.5% in Vanguard Short-Term Investment-Grade ($9.85; VFSTX), while our Long-Term Buy List has 34% in this relatively low-risk bond fund.


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