Bulls Bear Burden Of Proof


In an age where nearly everybody is a portfolio manager, responsible for retirement assets and etcetera whether you want to be or not, it’s worth remembering that defenders of an idea often have a hard time changing their minds. Once you argue that stocks are headed lower, that the jig is up and everything is rotten, you may find it hard to walk on the sunny side of the street.

One nice thing about the Dow Theory is its ability to shake up preconceptions. A bull market is one in which both the Dow Industrials and Dow Transports are reaching significant highs. A bear market is one in which both are reaching significant lows. If you’ve got an opinion on the market but the averages are saying otherwise, you may need to rethink your argument.

As we see things, a breakdown below the closing lows reached in early July — 9,686.48 on the Industrials and 3,906.23 on the Transports — would confirm the bearish primary trend under the Dow Theory. A rally above this spring’s respective highs of 11,205.03 and 4,806.01 would imply our recent shift into the bearish camp was premature.

For now, the burden of proof lies with the bulls. Until the averages begin charting higher highs — instead of lower lows — a bigger-than-normal cash position seems prudent. While we think stocks are priced to outperform bonds and money-market funds substantially over the next five to 10 years, we’re not convinced now is the time to be fully committed.

As a partial hedge, our Buy List and Focus List have 28.0% in Vanguard Short-Term Investment-Grade ($10.77; VFSTX), versus 31.0% for our Long-Term Buy List.

What could shift our stance

A near-term rebound above 11,205.03 and 4,806.01 would be the most bullish thing the averages could do. We don’t view such a breakout as likely, but that is precisely what would make it noteworthy. We’d also be encouraged by one or more of the following:

Avoidance of new lows. If one or both averages can hold above the early July lows, especially amid more bad economic news, the potential for a return to the bullish camp would improve.

A spike in bearish investor sentiment — without a breakdown to new lows. If bullish sentiment deteriorates further and stocks hold steady, it would suggest those most likely to exit the market have already sold.

Increased divergence among industry groups and stocks. Partly because of the increased popularity of exchange-traded funds, correlation among S&P 500 stocks recently reached the highest level since 1987. Increased divergence would suggest investors are done selling en masse — and beginning to look for values. One especially attractive value is Intel ($22; INTC).

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