Bearish Trend Indicated

1/11/2016


Hit by signs of weakness in China and downbeat manufacturing data, the Dow Industrials dropped below the Dec. 18 closing low of 17,128.55. The breakdown below that level is bearish, especially in light of the fresh 23-month low reached in the Dow Transports on Jan. 6.

With the close below 17,128.55, we view the primary trend as bearish under the Dow Theory — and are raising our cash position by selling some of our least-favored names. Community Health Systems ($24; CYH) is being dropped from the Buy and Long-Term Buy Lists. J.P. Morgan Chase ($63; JPM) is being dropped from the Buy List but retained as a Long-Term Buy, while Cisco Systems ($26; CSCO) is being removed from the Long-Term Buy List.

These changes boost our position in our cash proxy, the Vanguard Short-Term Corporate Bond ($79; VCSH) exchange-traded fund, to 21.2% to 21.4%. Depending on the market's reaction to December-quarter results and the opportunities available in individual stocks, we may raise our cash position again.

Broken-down indexes

In a choppy market trending mostly sideways, applying a trend-analysis system like the Dow Theory can be problematic. Partly because the averages have traded in such a narrow range over the past 18 months, relatively small percentage moves can take on significance.

For example, the Dec. 18-to-Dec. 29 bounce in the Industrials was just 3.5% — only slightly above the 3% threshold some early Dow Theorists used as the minimum for a significant move. But that 3.5% bounce retraced three-fourths of the Nov. 3-to-Dec. 18 decline, an unambiguously significant drop.

Also, unless we consider 17,128.55 significant, the next logical significant point is 8.5% lower, at the August low of 15,666.44. All the more reason to raise some cash now, before too much damage is done.

Looking beyond the Dow Industrials, the broader S&P 500 Index has charted a similar pattern, breaking below its Dec. 18 closing low to reach the lowest level since October. The small-company Russell 2000 and S&P SmallCap 600 indexes have broken down and are now testing the 2015 lows reached in September, as is the S&P Midcap 400 Index.

Conclusion

While we are wary of being whipsawed in a choppy market, recent action suggests the averages are discounting economic problems down the road. Subscribers should raise cash to about 21% of equity portfolios while looking for buying and selling opportunities one stock at a time.


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