Industrials reach new lows

7/7/2008


The market’s performance since early June has been abysmal, with stocks of nearly all stripes under pressure because of surging oil prices and mounting concerns regarding inflation and recession. The Dow Industrials’ breakdown below the March lows is discouraging, as are the recent sharp declines seen in the Dow Transports and other cyclical stocks.

While near-term volatility seems likely — and you should be quick to sell stocks that no longer rank among your favorites — we are reluctant to raise cash aggressively at current levels. With sentiment among investors very pessimistic and stocks oversold by some measures, a near-term bounce would not be surprising. Our Buy List and Focus List have 19% in Vanguard Short-Term Investment-Grade ($10.50; VFSTX), while our Long-Term Buy List has 17.5% in this low-risk bond fund.

Three scenarios
Using the Dow Theory is more like piloting than geometry. Like a pilot using a map and compass, you can use the Dow Theory to help you get where you’re going. But the Dow Theory will never provide absolute certainty regarding the market’s direction, and a willingness to question previous conclusions is crucial to succeeding in the stock market.

Our recommended cash position always depends on both the Dow Theory and the opportunities available in individual stocks. From a Dow Theory perspective, things could go one of three ways.

1. Confirmed new highs. If the Industrials rebound to close above 13,058.20 and the Transports close above 5,492.95, the bullish primary trend would be reconfirmed.

2. A breakdown below the March low in the Transports. With a close below 4,398.97 in the Transports, both the Industrials and Transports would be trading below prior significant lows — and the validity of April’s bull-market signal would have to be questioned.

3. Failed attempts at new highs. If the market rebounds without achieving new highs in both averages, then both averages move below the lows reached in the current correction, the Dow Theory would shift to the bearish camp.

Conclusion
Near-term trading will hinge on earnings warnings and earnings reports. For now, a wait-and-see attitude seems appropriate. Subscribers should watch the averages, hold 15% to 20% of equity portfolios in cash, and look for buying and selling opportunities on a stock-by-stock basis. For new buying, BMC Software ($36; NYSE: BMC) and Qualcomm ($46; NASDAQ: QCOM) appear especially attractive.


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