Greece Is The Word, For Now

5/3/2010


After marching steadily higher on better-than-expected earnings and encouraging economic data, stocks have dipped on concerns regarding debt contagion in Europe. The downgrade of Greece’s debt to junk status served as a reminder that the global economy still faces considerable risks — and provided an excuse for investors looking to take some money off the table.

Near-term volatility seems likely, and a pullback to 10,340 to 10,772 on the Dow Industrials would not be surprising. Still, with the primary trend in the bullish camp under the Dow Theory and quality stocks available at reasonable valuations, we are inclined to view a pullback as a correction in an ongoing bull market.

Holding some cash on the sidelines makes sense, and we are temporarily going above our 5% to 15% recommended cash range on our Long-Term Buy List as we await earnings reports from several potential additions. But subscribers should maintain a constructive and opportunistic stance toward equities, looking for opportunities one stock at a time.

Correction guidelines

Standard & Poor’s downgraded Greece’s debt on fears that a bailout from the European Union and International Monetary Fund will not be sufficient to prevent a restructuring of Greece’s government bond debt. Any such restructuring is likely to result in losses for debt holders, and investors fear other debt-burdened nations like Spain and Portugal face a similar fate.

The health of Europe’s economy is hugely important for U.S. exports and for the results of U.S. multinational companies, so the potential for a widening of the debt crises represents a serious threat to U.S. stocks. But the fact that Greece was downgraded to junk status should not have come as much of a surprise, and U.S. stocks were due for a breather.

Whether the recent dip will morph into a legitimate secondary correction is impossible to say, but history provides some guidelines on what to expect from such a correction:

Secondary corrections are usually blamed on a specific news development, but the real cause is a weakness in the market. When sentiment becomes too bullish and traders have accumulated big positions, even minor news developments can spark a correction. As founding Dow Theorist William Hamilton wrote: “One of the safeguards of a bull market is the secondary correction. It is the most effective check on excessive speculation.”

A typical secondary correction retraces one-third to two-thirds of the advance since the previous correction terminated. A retracement of one-third to two-thirds of the advance since early February would bring the Dow Industrials to 10,340 to 10,772, while the Dow Transports would retreat to 4,114 to 4,435.


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