Strategies For A Sideways Market

5/18/2015


Earnings season brought day-to-day volatility but no decisive breakout in the averages. Since November, the Dow Transports have traded in a range of 661 points, or nearly 8%. Since late October, the Dow Industrials and S&P 500 Index have traded in ranges of roughly 7%.

Dow Theorists attach considerable importance to such trading ranges, or "lines." William Hamilton, who codified and expanded on the writings of Charles Dow, said lines indicate a period of distribution or accumulation, though it's impossible to know which until the lines are violated.

"When the two averages rise above the high point of the line, the indication is strongly bullish," Hamilton wrote in The Stock Market Barometer. "If, however, the two averages break through the lower level, it is obvious that the market for stocks has reached what meteorologists would call ‘saturation point.' Precipitation follows."

Our game plan — and why

For now, we are maintaining a mostly invested but slightly cautious posture. Our Long-Term Buy List has 82.4% in stocks, versus 84.8% for our Buy and Focus lists. Our cash position is down slightly because of this week's rank changes, but the next substantial shift will likely follow a Dow Theory signal.

In other words, we are unlikely to raise cash aggressively unless the recent new lows in the Transports are confirmed by a close in the Industrials below 17,164.95. As always, our exact cash position will depend on the opportunities available in individual stocks and the clarity of any bear-market signal, including the action of advance-decline lines and other broad-market indicators.

At 17,164.95, the Industrials would be about 5% below current levels and 6.1% below the March 2 all-time high — a decent exit point compared to previous bear-market signals. One risk of going bearish, especially in today's choppy environment, is getting whipsawed by a quick snapback rally. However, this risk is mitigated by the close proximity of all-time highs. If both the Industrials and Transports rebound to all-time highs, the Dow Theory will be unequivocally bullish.

We are unlikely to become fully invested unless the bull market is reconfirmed with closes above 18,288.63 in the Industrials and 9,217.44 in the Transports. The Industrials are within 2% of 18,288.63, while the Transports would need to rally more than 7% to surpass 9,217.44.

With bond yields rising — and investors wondering whether that reflects improving expectations for the global economy or the first crack in a bond-market bubble — paying special attention to the Transports and other cyclical stocks seems especially appropriate today.


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