Amid Scandals, Stocks Slump

5/22/2017


Stocks have dropped, hurt by fallout from the latest scandal in the White House. Not only are investors questioning whether Republicans can deliver promised pro-business reforms on taxes and regulation, but many also worry about a deepening crisis in Washington.

Raising cash aggressively at this point seems premature. For now, with the earnings outlook favorable and the Dow Theory still in the bullish camp, we are maintaining a mostly invested posture. Our buy lists have 89% to 92% in stocks.

The state of the Dow Theory

After bouncing more than 4.5% from the April 13 closing low of 8,874.56, the Dow Transports reversed course, breaking below 8,874.56 in a broad market decline. The Transports, historically a good barometer for the more cyclical parts of the U.S. economy, are down 2.9% so far in 2017.

The Dow Industrials gained nearly 3% from April 19 to May 8, coming within 120 points of the March 1 all-time high of 21,115.55. But the rally came up short, and the Industrials have now dropped within 1% of the April 19 closing low of 20,404.49.

We're not convinced that a break below 20,404.49 would represent a bear-market signal under the Dow Theory, as the decline that brought the Industrials to that point retraced only 22% of the November-to-March advance. Typically, significant corrections retrace one-third to two-thirds of the preceding advance.

Still, a close below 20,404.49 would be reason enough to raise some cash, as it would suggest a significant correction is under way. A one-third retracement of the November-to-March advance would put the Industrials at 20,040, while a two-thirds retracement would put the index near 18,965. 

What to do now

While nearly all sectors have slumped recently, financials and technology stocks have pulled back sharply. Bank stocks have been hurt by the drop in bond yields, as investors expect rising yields to help net interest margins. Technology, this year's best performer, has been hurt by profit-taking.

We think abandoning these sectors now would be a mistake. Both rank among the top three sectors based on average Overall Quadrix score. Both sectors include some reasonably valued growers, even without policy reform in Washington.

If the Dow Industrials close below 20,404.49, our stock-market exposure will likely be reduced to a range of 80% to 85%. For now, we intend to hold 8% to 11% cash positions while looking for buying opportunities. Citizens Financial ($35; CFG) and ON Semiconductor ($15; ON) have dipped into attractive price ranges.


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