Crosscurrent Slam Stocks

10/6/2014


When a stock-market expert starts talking about crosscurrents, it's often a tacit admission that he or she doesn't know which way things are headed. But your editor freely admits he doesn't know the market's near-term direction, and this does seem like a good time to mention the crosscurrents swirling on Wall Street.

Amid mostly solid U.S. economic news and mostly disappointing news abroad, the Dow Industrials and S&P 500 Index are trading within 4% of the all-time highs reached in mid-September. Foreign stocks have taken a hit, with the MSCI EAFE Index down 10% from its June high. Meanwhile, prices for oil and other commodities have slumped amid signs of a slowdown in China and strength in the U.S. dollar.

Among U.S. stocks, strength in big blue chips is masking broad deterioration. As measured by the advance-decline line for stocks in the broad S&P 1500 Index, the market has been under pressure since early September — and has made no progress since May. The S&P SmallCap 600 Index has slumped more than 9% since early July. Among the 155 equal-weighted industry groups tracked in our Group Studies report, only five have delivered positive returns since the end of August.

Our advice

While nobody knows exactly how today's crosscurrents will play out, we expect the next 20% move in the market to be up. More important, we know exactly how we intend to proceed.

First, we're dropping any stocks that no longer rank among our favorites for new buying. Dow Chemical ($50; DOW) is being downgraded today. The move brings the cash position on our Focus List and Buy List up to 6.1%, versus 8.1% for our Long-Term Buy List. We are always looking for downgrade candidates, and we will be quick to sell any stock that no longer represents a compelling buy.

Second, we're looking for new buys. Periods of market turmoil can open buying opportunities, and we'll be looking for bona fide growers that pull into attractive valuation ranges. While Lear ($87; LEA) and Magna International ($96; MGA) are already on our buy lists, we see the sell-off in these auto-parts suppliers as a buying opportunity.

Third, we intend to watch the averages and advance-decline lines, especially as third-quarter earnings are announced. Are small stocks slumping because they have become expensive? Or do investors see a global slowdown threatening the favorable trends in U.S. corporate profits? The reaction to third-quarter results should help answer those questions.

Fourth, we intend to watch sentiment indicators closely. We'd like to see bullish sentiment decline sharply in response to any further market declines.


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