Broad Market Under Pressure

9/29/2014


The Dow Industrials, Dow Transports, and S&P 500 Index closed at all-time highs on Sept. 18. But the broad market has not made any headway since early July, heightening the risk of a near-term correction.

With the Dow Theory squarely in the bullish camp and quality stocks available at reasonable valuations, we are inclined to view a pullback as a buying opportunity. Our buy lists have 94% to 98% in stocks.

Narrow advance

When the generals lead and the soldiers don't follow, sustaining an advance is difficult. The same holds true with stocks, so many are worried about the narrow nature of the market's latest push higher.

Even among the big stocks in the S&P 500, gains among the largest components have masked underlying deterioration. The S&P 500 advance-decline line, a running total of advancing minus declining stocks, last made a new high on Sept. 5. For stocks in the S&P SmallCap 600, the advance-decline line peaked on July 3.

Also worrying some analysts: A pullback seems overdue. The Dow Industrials have not closed 10% below a previous high in more than 700 trading days, according to S&P Capital IQ. That is the fourth-longest such streak since 1929.

Profitably trading based on such historical norms is difficult. The Industrials went 1,132 trading days without a 10% correction from 2005 to 2007 — and 1,705 days from 1991 to 1997.

Our intermediate potential risk indicator, based on the percentage of stocks on the New York Stock Exchange trading above their 200-day moving average, suggests a fair amount of damage has already been done. At 46%, the percentage is down sharply from 78% on July 3.

Sentiment indicators suggest the correction may have further to go. Among investment newsletters, the percentage of bulls exceeds the percentage of bears by 33%, down from 43% on Sept. 9 but still above long-term norms, according to Investors Intelligence. Among individuals, surveys point to higher-than-usual bullishness.

Our advice

While the risk of a correction appears elevated, nobody knows whether the market's next 10% move will be up or down. Instead of trying to time every zig and zag in the averages, focus on the primary trend and the availability of attractive stocks. With the median S&P 500 stock trading at a 7% premium to the 20-year norm based on trailing P/E ratio, we are still finding enough quality growers to fill out our portfolios.


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