For Now, Bounce Proves Nothing


Stocks have bounced, with speculation surrounding China's moves to stimulate its flagging economy triggering some bargain-hunting. For now, with the Dow Theory in the bearish camp, subscribers should maintain a defensive posture. Our Long-Term Buy List has 70% exposure to stocks. Our Buy List, after this week's addition of C.H. Robinson ($69; CHRW), has 71.4%.

Two possibilities

Just as there are secondary corrections in bull markets, there are secondary rallies in bear markets. Even when underlying fundamentals are deteriorating, stocks will periodically rally in bear markets when sentiment gets overly bearish.

Every bear-market rally could potentially represent the first stage of a new bull market. To differentiate between these two possibilities, Dow Theorists look at the market averages' ability to hold above previous significant lows and penetrate significant highs.

In the near term, the market's ability to hold above its Aug. 25 closing lows of 15,666.44 in the Dow Industrials and 7,466.97 in the Dow Transports will be crucial. Both averages rallied more than 5% from those lows, with both retracing more than 30% of the preceding decline from all-time highs.

If both averages move below the Aug. 25 lows, the bear market would be reconfirmed. But if one or both averages can hold above the Aug. 25 lows on the market's next downdraft, the first criterion for a return to the bullish camp would be satisfied.

At that point, a rebound in both averages above previous significant highs would represent a bull-market signal. Also, if both averages rally to all-time highs without interruption, we'd have to conclude that the Aug. 20 bear-market signal was incorrect, as it makes no sense to label the primary trend as bearish if both averages are at all-times. A return to all-time highs would require rallies of 12% in the Industrials and 15% in the Transports.

Our intermediate potential risk indicator, based on the percentage of New York Stock Exchange stocks trading above their 200-day moving averages, suggests stocks remain oversold and could have further to bounce in the near term.

Sentiment also suggests the recent bounce could be extended, as individuals and advisers are quite bearish. In fact, according to Investors Intelligence, bearish newsletters outnumber bullish newsletters for the first time since 2011.


Sentiment indicators suggest the rally may have further to run in the near term. But at least one average will need to hold above the Aug. 25 closing lows for a return to the bullish camp, and we intend to hold an above-normal cash position until both averages reach significant highs.

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