Market Rallies

7/11/2011


The stock market recently registered its best one-week performance in two years. With second-quarter earnings season nearly upon us, it would not be surprising for stocks to show above-average volatility in the near term. For now, our equity portfolios have about 10% in a short-term bond fund.

Waiting for the Dow Industrials

The week ended July 1 saw the Dow Jones Industrial Average rise 648 points, or 5.4%, the largest weekly percentage gain for the index since July 2009 and the largest weekly point gain since November 2008.

The Dow Transports, too, had a great week, jumping 6.4% to a new all-time high.

That the economically sensitive Dow Transports are trading at all-time highs is especially significant given that the U.S. economy has its share of naysayers. Indeed, fears of a significant economic slowdown at least partially drove the Dow's pullback from May to mid-June.

To be sure, new highs in the Dow Transports do not necessarily give an all-clear signal for the stock market. Under the Dow Theory, the movement of the Dow Industrials and Transports should always be considered together. And while the Dow Transports have eclipsed their previous important high of 5,527.50, the Dow Industrials have yet to top their April 29 high of 12,810.54.

The timing of the recent market rally is noteworthy, as it comes at the onset of corporate earnings season. The stock market's gains in the last two-plus years have been powered in large part by corporate profits that have consistently beaten expectations. If the Dow Industrials are going to surpass their previous high, this trend must continue.

Thus, investors should watch closely over the next few weeks to see how stocks respond to earnings announcements and guidance provided by companies. New highs by the Industrials would be positive for the market. However, a failure of the Dow Industrials to go to new highs, followed by a breakdown in both the Dow Transports and Industrials below the lows established in June, would be a negative development for stocks.

Conclusion

While the recent highs in the Dow Transports are encouraging, the Dow Industrials need to close above their previous high of 12,810.54 in order to reconfirm the bullish trend. For now, hold about 10% of your equity portfolio in a short-term bond fund. For investors underweighted in equities, satellite-television providers DirecTV ($52; DTV) and DISH Network ($31; DISH) offer especially attractive capital-gains potential.


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