Market Bounce Raises Questions

3/28/2011


After sliding more than 6% over nearly four weeks, the Dow Industrials and Dow Transports have bounced on bargain-hunting and signs of stabilization at Japan's troubled nuclear facility. Both averages are within 4.5% of their mid-February highs — 12,391.25 on the Industrials and 5,298.10 on the Transports — and a close above those points would reconfirm the bullish primary trend. For now, as a partial hedge, our buy lists hold 12% to 15% in Vanguard Short-Term Investment-Grade ($10.75; VFSTX), a relatively low-risk bond fund.

Significant questions

Three things must happen for a bear-market signal under the Dow Theory. First, the Industrials and Transports must suffer significant corrections. Second, one or both averages must fail to rally above their precorrection highs in their subsequent rebounds. Third, both averages must drop below the lows established in the correction.

While that sounds simple enough, the question of whether the averages have suffered a significant correction can lead to some borderline decisions. Under the Dow Theory, significant corrections typically retrace 33% to 67% of the preceding advance over three to 12 weeks.

At the closing lows reached March 16, the Industrials had retraced 32% of the August-to-February advance, versus 29% for the Dow Transports. So, the question is whether the declines from mid-February to March 16 qualify as significant, even though neither met the strict parameters of a secondary correction. If those declines qualify as significant, the March 16 closing lows of 11,613.30 and 4,950.00 would represent significant points, meaning closes below those points could represent a bear-market signal.

Conclusion

At this point, after a three-day bounce in the averages, concluding that the March 16 lows are significant seems premature. Still, a close below those levels would be a discouraging development. A rebound to new highs in both averages would be bullish. For new buying, top year-ahead picks include Apple ($341; AAPL), Exxon Mobil ($83; XOM), and IBM ($158; IBM).


DOW INDUSTRIALS

 

DOW TRANSPORTS


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