Rescue Efforts Extend Rally



The market has extended its rally, with optimism regarding the government’s financial-rescue efforts lifting the Dow Industrials to seven-week highs. Also supporting stocks have been some better-than-expected readings on the economy, which have helped the Dow Transports and other cyclical names.

While the market’s rally since March 9 has been impressive, bear-market rallies tend to be impressive. For now, with the Dow Theory in the bearish camp, holding a sizable cash position in equity portfolios seems prudent. Our Buy List and Focus List hold 35.2% in Vanguard Short-Term Investment-Grade ($9.72; VFSTX), versus 34% for our Long-Term Buy List.

Listen to the averages
“In a primary bear market the rallies are apt to be violent and erratic, and always occupy less time than the decline which they partially recover,” according to founding Dow Theorist William Hamilton.

While Hamilton would be the first to admit that the advance since March 9 may well represent the first leg of a new bull market, the breadth and rapidity of the upturn is characteristic of a bear-market rally. Before a recent dip, the Dow Industrials had surged 19% in 10 trading days.

Still, there is little to be gained — and much to lose — by deciding right now whether the market bottomed March 9. Instead, subscribers should listen to the averages, resisting the temptation to draw premature conclusions.

If the Industrials and Transports can extend their rally for another couple of weeks, the March 9 closing lows in both averages will take on added significance. Moves in both averages below those lows would reaffirm the market’s bearish trend — and make clear that the recent bounce was a bear-market rally.

Also worth watching are the financials, which have led the market to both the downside and the upside over the last six months. The S&P 500 Financial Sector Index has jumped 53% from its March 6 low, with many major bank stocks doubling.

Some analysts say that the huge rallies are a sure sign of speculation, that fundamentals cannot justify such outsized moves. But such arguments overlook the leverage inherent in banks’ balance sheets. Consider Wells Fargo ($16; WFC), with reported loans outstanding of $865 billion on Dec. 31. A mere 7% difference in the estimated value of these loans amounts to $61 billion — nearly equal to Wells Fargo’s total stock-market value.

The Dow Theory remains in the bearish camp. Despite the volatility seen in financials, the sector remains a crucial bellwether for the broad market.

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