Bulls And Bears In Standoff


As the strife in Libya continues and oil prices hover near recent highs, the Dow Industrials and Dow Transports remain caught in a trading range — unable to rebound above the mid-February highs but so far avoiding a significant retreat. For now, as a partial hedge, we're keeping 10% to 15% of our buy lists in a short-term bond fund.

Cyclical strength

With the Dow Industrials up 87% from the March 2009 low, oil prices surging, and the typical U.S. stock no longer cheap relative to historical norms, investors have had no shortage of reasons to lock up some profits. Yet the Industrials are within 2% of the Feb. 18 closing high of 12,391.25, while the Transports are within 3% of their Feb. 17 high of 5,298.10.

Bears attribute the resiliency of the averages to investor complacency. Surveys, including the Investors Intelligence poll of investment newsletters reveal a fairly high level of optimism. Inflows into equity mutual funds, historically a good barometer for sentiment among individual investors, have remained positive amid the scary headlines of the past month.

Fund managers have little choice but to invest the inflows — or risk falling behind their benchmark index. But, bears argue, a day of reckoning approaches as investors realize that the economy is recovering only because of government-subsidized steroids, that U.S. and European debt loads are simply not sustainable, that inflation and interest rates are headed sharply higher, or etcetera.

Perhaps. Or perhaps stock prices are resilient because the trends that drove the one-way rally since early December remain intact, including mostly encouraging economic news and earnings-estimate trends. The Citigroup Economic Surprise Index, which advances when economic reports exceed consensus estimates, reached an all-time high in early March.

Since year-end, consensus estimates for S&P 500 Index earnings in the March, June, and September quarters have increased. The consensus for 2011 growth has edged higher to nearly 14%, with estimates for the economically sensitive energy, financials, and materials sectors recording the biggest increases.


A near-term decline will not vindicate the bears, as a pullback would be consistent with a correction in a bull market. For Dow Theorists, the argument will be settled by the averages' ability to rebound from such a correction and reach new highs. New rally highs in the Industrials and Transports would indicate the bull market remains intact, while a failure to reach new highs in both averages would be discouraging.

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