Both Averages Must Confirm

9/18/2017


Helped by a broad market advance, the Dow Industrials, S&P 500 Index, and NASDAQ Composite reached all-time highs. So did the S&P 1500 advance-decline line, a running daily total of advancing minus declining stocks. The Dow Transports rallied within 2.2% of the July all-time high of 9,742.76, and a close above that level is needed to reconfirm the bullish primary trend under the Dow Theory. For now, we intend to watch the averages while maintaining a nearly fully invested posture. Our buy lists have 94% to 97% in stocks.

Dow Theory update

"There is one fairly safe rule about reading the averages, even if it is a negative one. This is that half an indication is not necessarily better than no indication at all. The two averages must confirm each other."

That is how William Hamilton, a founding Dow theorist, described the concept of confirmation. While a lot has changed since he wrote those words in 1928, the underlying logic remains the same: Because the Industrials and Transports represent different parts of the market, insisting on new highs or new lows from both reduces the risk of a false signal.

If one average is lifted to significant highs by a fleeting rally in a few stocks, the status of the Dow Theory is not affected unless the other average also reaches a new high. For example, without a close above 9,742.76 in the Transports, this month's unconfirmed new high in the Industrials is basically a nonevent.

Confirmed new highs would signal that continued gains are likely — and that prior significant lows are no longer relevant. Without confirmation from the Transports, prior significant lows remain actionable, meaning breakdowns below those points could trigger a bear-market signal.

The Transports' Aug. 24 low of 9,021.12, which came after a six-week retreat of 7.4%, is clearly significant. But the Industrials' Aug. 18 low of 21,674.51 came after a two-week decline of 2%, and labeling such a minor dip as significant is problematic.

Still, if the Transports fail to close above 9,742.76, a breakdown below 9,021.12 in the Transports and 21,674.51 in the Industrials would be discouraging — and reason enough for us to raise some cash.

Conclusion

The last important Dow Theory signal came in July, when both averages reached all-time highs to reconfirm the bullish trend. For now, with the broad market advancing and the Transports within striking distance of a bull-market confirmation, our buy lists have 94% to 97% in stocks. For new buying, top picks include Celgene ($141; CELG) and Facebook ($173; FB).


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