Averages Hit Significant Highs

10/19/2015


The Dow Transports closed above their Sept. 17 closing high of 8,215.44, confirming an earlier move to significant highs in the Dow Industrials.

With both averages closing above previous significant highs, it's hard to argue the primary trend is bearish. We're not going to try. While we'd like to see better action from the broad market, and we'd like to see stocks respond positively to third-quarter results, we're going to listen to the averages. The equity exposure of our buy lists has been increased to 78% to 80%.

We'll be looking for buying opportunities as third-quarter results are announced, and we won't be afraid to purchase names that rally on encouraging results — so long as valuations remain attractive.

Binary system

You can't always get what you want, especially when it comes to watching the averages.

Last week on this page we said we'd prefer that the Transports hold off on confirming the new highs in the Industrials until earnings-reporting season was fully under way. Two days after last week's newsletter was posted on our web site, the Transports closed above 8,215.44. And three days after that, the Transports were back below 8,215.44, partly because railroad stocks dipped after CSX ($27; CSX) kicked off earnings season for the group with in-line but downbeat quarterly results.

Is it silly to attach significance to a point like 8,215.44, especially when the market was not able to build on the breakout above that level?

A bit. Remember, even founding Dow Theorist William Hamilton argued that "the road to ruin lies in dogmatizing on charts, systems and generalizations." Still, we don't think investors should dismiss the move to new highs as meaningless, for several reasons:

First, the Dow Theory is a binary system, and such a system needs well-defined rules. In our view, the mid-September highs in the Industrials and Transports were unambiguously significant, as both highs were reached after substantial three-week rallies.

Second, the Dow Theory has compiled an impressive track record over the past 100-plus years. The theory is not infallible, but history suggests stocks are more likely to rise when both the Industrials and Transports are tracing out patterns of higher highs and higher lows.

Third, nothing says the Dow Theory must be used in an all-or-nothing fashion. The Dow Theory is either bullish or bearish. But that does not mean we must treat every bull- or bear-market signal the same way. Today, we'd be more inclined to take the recent bull signal at face value if stocks were cheaper and more groups were participating in the recent rally.


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