Your Questions Answered

9/20/2010


Q What is the state of the Dow Theory?
A As we see things, the Dow Theory turned bearish on June 30, when both the Dow Industrials and Dow Transports closed below the June 7 lows of 9,816.49 and 4,037.98.

Q So why is Dow Theory Forecasts telling investors to watch for a breakout above this year’s respective highs of 11,205.03 and 4,806.01 or below the July lows of 9,686.48 and 3,906.23?
A A bear market is one in which the averages reach significant lows, and neither average has done so since early July. The longer the averages avoid a breakdown to new lows, the more significant the July lows become — and the greater the likelihood that the June 30 bear-market signal was premature. Still, the primary trend is presumed intact until proved otherwise, so moves to new highs above 11,205.03 and 4,806.01 are needed to put the Dow Theory in the bullish camp.

Q So, what should subscribers do with their portfolios?
A Of the portion of your portfolio allocated to equities for the long term, hold 25% to 30% in a relatively low-risk bond fund like Vanguard Short-Term Investment-Grade ($10.84; VFSTX). With the remaining 70% to 75%, emphasize attractively valued shares of high-quality stocks, like our recommendations listed on page 7.

Q If the Dow Theory is still in the bearish camp, why are you recommending investors own stocks?
AFirst, we don’t believe in timing the stock market in an all-or-nothing fashion. Moving completely in and out of the market is among the easiest ways to destroy your long-term returns, partly because market-timing is difficult and partly because it becomes even more difficult when you are limited to all-or-nothing moves.

Second, we expect stocks to deliver much-improved relative returns over the next decade. While we’re not convinced now is the optimal time to be fully invested in stocks, we expect stocks to outperform bonds handily over the next 10 years.

Third, our recommended stock-market exposure depends on both the Dow Theory and the opportunities available in individual stocks. With high-quality stocks available at relatively modest valuations, we face no shortage of attractive opportunities.

Q Aren’t you worried that Vanguard Short-Term Investment-Grade will slump when interest rates rise?
A Like all bond funds, the fund’s price per share will tend to drop when interest rates rise. But the fund, with a yield of nearly 2%, limits interest-rate risk by holding short-term bonds. The average weighted maturity of the fund’s bond holdings is about 3.1 years. The average duration is 2.3 years, meaning the fund’s price is expected to decline 2.3% if interest rates rise by one percentage point.


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