Key Points Established

12/5/2011


Fueled primarily by ongoing news from the euro zone, market volatility remains high, with stocks showing big daily swings. However, while the volatility is drawing a lot of headlines, that news overshadows what is mapping out as a fairly traditional market pattern under the Dow Theory:

• Following a shift to the bearish camp Aug. 2, the Dow Industrials and Transports fell sharply over the next couple of months, bottoming on Oct. 3 at 10,655.30 on the Industrials and 4,038.73 on the Transports.

• The Dow Theory states that typical "corrections" within bear markets last three weeks to three months and retrace one-third to two-thirds of the previous decline. Interestingly, from Oct. 3 to Oct. 28, the Dow Industrials retraced slightly more than two-thirds of the previous decline, rallying 1,575 points to 12,231.11. The Dow Transportation Average had a similar move, retracing around two-thirds of its previous decline to reach 5,025.09 on Oct. 27.

• The Dow Theory states that after such rallies during bear markets, investors should expect a retest of previous lows. To that end, the Dow Industrials declined roughly 1,000 points from the Oct. 28 level, or 8%, before bouncing sharply in recent trading. The Dow Transports saw a similar decline, falling roughly 10% from their Oct. 27 rally high before rebounding. Whether the retest goes deeper and approaches the Oct. 3 lows remains to be seen, but the sharp declines in the averages from late-October highs met the parameters of a meaningful retest under the Dow Theory.

With key high and low points now established under the Dow Theory, the next major market move will have significant implications for the market's primary trend. Should one or both of the Dow averages hold their Oct. 3 lows, then both averages close above their late-October rally highs — 12,231.11 on the Industrials and 5,025.09 on the Transports — the stock market's primary trend would turn bullish, according to the Dow Theory.

Conversely, closes in the Industrials and Transports below their respective Oct. 3 lows of 10,655.30 and 4,038.73 would reconfirm the bearish trend.

Conclusion

For now, our buy lists have 21% to 22% in a short-term bond fund, with the remainder in stocks. For investors who find themselves holding more cash than our 21% to 22% target, Apple ($373; AAPL), Google ($583; GOOG), and Intel ($24; INTC) represent three excellent values in the tech sector and are attractive buys at current prices.


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