The Dow Marches On

The stock market has demonstrated tireless resiliency in the face of challenging headline news and geopolitical events since its bottom in March 2009. Now, some four years later, the burden of some of these once gripping issues has been lifted. This was most recently depicted on February 25 when the major stock indices sold off sharply following the Italian elections, swiftly recovering and climbing to record high levels in a chain of daily advances the likes of which had not been witnessed since 1996. Although this abrupt pullback was a reminder that concerns still remain concerning Europe, the action in the ‘fear index’ (the CBOE Volatility Index) was telling in that reaction was limited. The latest spike in this index complied with a longer-term series of descending peaks, implying that the market has largely discounted investors’ greatest worries about the Eurozone and other once troubling topics. Other uncertainties such as China and the U.S. Presidential election outcome also appear in the market’s rearview mirror, leaving investors and analysts to focus instead on such traditional factors as interest rates and earnings when assessing the risk/reward ratios for stocks.

There are legitimate and understandable reasons to expect a pullback with the DJIA’s stunning year to date advance, up about 11%. While I would not deny that a correction is due, the very fact that predictions of a decline have become more frequent might mean that a substantial decline could be elusive until the stock market reaches considerably higher ground. From my technical perspective it does not appear that the stocks are overvalued or overbought to the extent that the market is in danger of a 10% or greater retreat, even though more investors may be ‘obsessing’ about a pullback. The market has done an admirable job of policing its excesses on an ongoing basis through individual stock consolidations and rotational sector backing and filling. This has kept speculation in check, valuations at attractive levels and the many different and diverse leadership groups in balance with no one sector substantially outpacing another for very long. My conclusion is this: the market’s risk/reward ratio remains attractive both short term and longer term.

It is my contention that at DJIA current levels near 14,500, predicting the timing or depth of a decline could prove difficult and may even be distracting given the broad field of technically attractive stocks at this juncture. In fact, given my observation that non-institutional net money flows have indicated accumulation trends in stocks for several years and have only recently been accompanied and bolstered by net buying activity among institutions, the market may be embarking on a more aggressive course to higher levels. While some market observers have expressed disappointment regarding the market’s volume trends, I have always maintained that turnover alone is not an appropriate measure of momentum. In my opinion, it is far more important to determine what the underlying accumulation/distribution characteristics are for individual stocks and the overall market. Those who have been awaiting a ‘breakout’ in general market volume may well have risked missing the lion’s share of this advance since March 2009.

From the start of 2013, the Dow Jones Transportation Index has held a commanding lead over the Industrials. Dow Theory has long maintained that this scenario – transports leading the industrials higher – is a recipe for a sustained market drive. I would not put full faith in this occurrence alone, but it so happens that this indicator compliments a number of other technical, fundamental and quantitative factors that are aligned in favor of bulls. Related to the relative strength of the transportation stocks is the bullish posture of the manufacturing sector. Manufacturers have been and remain one of my favorite market categories in this cycle. Similar to most other leadership groups there is good depth of leadership based on both numerous attractive stocks in the respective subcategories as well as good representation of large, medium and small cap companies.

Based on the attractive technical qualities of the market’s advance this year, DJIA 14,000 could become a meaningful and enduring support area. This would represent a relatively mild retreat of 3%. While a millennium level can provide important technical and psychological underpinnings for a market that is gathering upward momentum, I would regard the DJIA’s pivotal lows on February 25 as meaningful as well. A test of that area would equate to a decline of about 5%, a still moderate retracement when taking into account the market’s longer-term achievements along with its shorter-term feats. Although DJIA 15,100 represents my 2013 objective area this could prove conservative if the Fed remains committed to a transparent monetary policy and earnings continue to grow beyond Wall Street’s consensus expectations.

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© Advisors Asset Management

© Advisors Asset Management

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