June Lows At Risk

8/1/2011


Hurt by the U.S. debt-limit impasse and signs of slowing industrial demand, the major averages have been under pressure. Continued volatility seems likely as earnings season rolls on, the debt-limit debate continues in Washington, and worries regarding Europe's sovereign-debt crisis linger.

Subscribers should maintain a mostly invested posture while watching the averages and looking for opportunities on a stock-by-stock basis. A breakdown below the June lows of 11,897.27 in the Dow Industrials and 5,060.59 in the Dow Transports would be bearish, while a move above this year's highs would be bullish. As a partial hedge, our equity portfolios have 11% to 12% in a short-term bond fund.

Debt debate

Are our elected officials really going to drive the U.S. economy off a cliff by failing to raise the U.S. debt limit, risking default and reneging on our obligations? It seems hard to believe, and until recently financial markets did not seem to view the standoff as a serious threat.

But investors have become more nervous as the Treasury's Aug. 2 deadline approaches, with gold prices reaching fresh highs and the U.S. dollar slumping broadly relative to other currencies. In the market for Treasury bills, yields on paper maturing in August moved above yields on September maturities, signaling at least some investors are worried about the Treasury missing a payment.

More ominously, investors are worried that U.S. debt will lose its triple-A credit rating. Debt-rating agency Standard & Poor's says it plans a rating downgrade unless it sees a credible plan to reduce future deficits by $4 trillion over the next 10 years — even if the debt ceiling is lifted.

Yields on 10-year and 30-year Treasury bonds remain near recent lows, suggesting bond investors still view the U.S. as creditworthy. But stocks have retreated, partly on indications that growth in global industrial markets is slowing. With the Dow Industrials and Dow Transports within 4% of the June closing lows, a near-term bear-market signal is possible.

Conclusion

While we think the debt-ceiling impasse will be resolved without a default, we intend to listen to the averages. With closes below 11,897.27 and 5,060.59, the stock-market exposure of our equity portfolios will be cut to 80% immediately — and our hotline will be updated with specific instructions. Among our recommendations, Apple ($403; AAPL), Bed Bath & Beyond ($60; BBBY), and MasterCard ($313; MA) are especially attractive.


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