Plan For Surprises


The major averages have hit some resistance, with the Dow Industrials and Dow Transports unable to net much progress since mid-March despite mostly solid U.S. economic news. Investors worry about the global economic environment, helping to bring yields on 10-year Treasury bonds near two-month lows. For now, we intend to watch the averages while keeping 81% to 82% of our buy lists in stocks.

Keep an open mind

When market conditions are choppy and the market's primary trend hard to discern, it's especially crucial to keep your eyes and mind open — and plan for surprises.

"Plans are useless," said Gen. Dwight Eisenhower, "but planning is indispensable."

The World War II hero and U.S. president was talking about preparing for battle, about the need to be flexible and adaptable when facing the uncertainty of war. But investors should keep the lesson in mind as they look ahead to first-quarter earnings season.

No matter how well you've anticipated market moves of late, the worst thing you can do is conclude you've figured things out. The best investors remain intellectually humble; confident in their ability but fully aware that the world is a complicated place — and that predicting the future consistently is very difficult.

Instead of making a forecast and putting all their eggs in that basket, smart investors regularly second-guess themselves. They don't close their eyes to evidence indicating they might be wrong. Instead, they seek out such evidence — and consider how to react if proved wrong.

For investors trying to determine the primary trend, one advantage of the Dow Theory is its reliance on significant highs and lows. When both averages are reaching significant highs, the primary trend is bullish. And when both are reaching significant lows, the primary trend is bearish.

Looking ahead, investors should plan for the following scenarios:

• All-time highs in both the Industrials and Transports would put the Dow Theory squarely in the bullish camp. The Industrials are within 4% of their all-time high of 18,312.39. But the Transports are more than 19% below 9,217.44, so this scenario seems unlikely to unfold anytime soon.

• More likely is a move above the November highs of 17,918.15 in the Industrials and 8,301.80 in the Transports. Both averages suffered significant corrections from those levels, so a near-term rally above the November highs would undermine our confidence in our bearish view — and likely prompt us to reduce our cash position somewhat.

• A breakdown below this year's lows of 15,660.18 in the Industrials and 6,625.53 in the Transports would reconfirm the bearish trend — and prompt us to raise more cash.

• A meaningful pullback from current levels, would set the stage for a conventional Dow Theory signal. At that point, either the averages will rebound above the highs established in the current rally (providing a bull-market signal, and a reason to lower our cash position) or they will break below this year's lows (providing a bear-market confirmation, and a reason to raise cash).

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