Waiting On A Correction

7/6/2009


After a pullback, the averages have stabilized within the trading ranges that have prevailed since early May. Near-term trading is likely to hinge on June-quarter results, so volatility in both directions seems likely. With the Dow Theory still on a bear-market signal, we’re keeping about 30% of equity portfolios in Vanguard Short-Term Investment-Grade ($10.23; VFSTX).

Impatient consumers
U.S. consumers appear to be losing some patience with the pace of economic recovery, partly because of weakness in the job market. The Conference Board said consumer confidence dipped in June following three consecutive monthly increases, with the percentage of respondents saying jobs are hard to get rising to 44.8% — close to a 16-year high.

By contrast, investors in U.S. stocks seem content to wait for the recovery to materialize. Despite several reports pointing to continued weakness in U.S. consumer spending, which accounts for about two-thirds of the U.S. economy, the Dow Industrials have yet to suffer even a 6% pullback since March.

The Dow Transports, historically a good barometer for the more cyclical parts of the U.S. economy, fell 12% from May 6 to May 13. But the Transports have moved slightly higher since May 13 amid some seemingly bearish news. Shares of United Parcel Service ($50; UPS) and FedEx ($55; FDX) have bounced despite a profit warning from FedEx, and railroad stocks have held firm despite continuing weakness in weekly freight-car loadings.

As a very general rule of thumb, significant corrections retrace one-third to two-thirds of the preceding advance. From highs reached in May and June, moves to 7,300 to 8,050 on the Industrials and 2,565 to 2,985 on the Transports would qualify as significant. Partly because neither average has suffered such a decline, we would not view a near-term move above the May and June highs as a bull-market signal.

Bears argue that the market’s resilience reflects easy money and misplaced hopes, while bulls argue that stocks always move in advance of the economy. Moreover, argue the bulls, U.S.-traded companies increasingly rely on overseas economies for growth, and China’s purchasing managers’ index rose for a fourth consecutive month in June.

Conclusion
When listening to the market, you can’t rush the averages. Only after both averages suffer significant corrections — then rebound above the highs of the current rally — will we know the bear market ended in March. In the meantime, subscribers should hold some cash on the sidelines and look for attractively valued growers, such as Hospira ($39; HSP).


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