Tuesday, July 27, 2010

Watching Dow Theory

Two important Dow Theory events recently serve as a possible harbinger for a near-term resumption in the Bull Market within the on-going Bear Market in stocks. Back on June 7, the Dow Industrials violated the previous most recent lowest low in February by closing at 9816.49. Significantly, however, the Transportation Index never confirmed the action of the Dow. Even though the Dow continued to move lower in June, the Transports never violated their previous February low.

This classic Dow Theory “non-confirmation” often means a reversal of the present trend. In this case, it meant a possible swing back to the upside for the markets. The focus for the theory then shifted to the most recent highest high (also coincidentally in June). If both averages could better their June highs then we would have a classic Dow Theory “confirmation”; in this case, confirmation of the reversal in market forces.

That is what happened yesterday.

Dow Theory confirmations and non-confirmations are always worth noting. But, when a non-confirmation is followed relatively quickly by a confirmation of the reversal it is, perhaps, a more powerful statement. The Bull is now back in the driver’s seat according to Dow Theory.

Probably the worse thing you can do as an investor is to get yourself into a mindset of thinking you know what is actually going to happen and become emotionally attached to the structuring of your portfolio. So, dispassionately, I have to admit that the gloomy prognostication of a double dip in the Great Recession might not come to pass. Although the possibility still lingers, more than likely it will not happen in the near future. This market wants to go up. Well, good for it and for stockholders everywhere. I’m really not the kind of guy that prefers a world of mass misery. I hope we all get wealthier.

Meanwhile, the fear of deflation looms. This means the price of gold is going to take a hit. Today, in fact, it took a big hit. This does not discourage me, however. Again, it is better to keep emotions out of the decision-making process where money matters. Instead, I view this as the set up for an excellent entry point into gold. I am accumulating more as the price drops because, as I have posted before, I still feel that the central banks of the world will do everything in their power to fight deflation. They will open up the money spickets. That should be good for gold.

As for the apparent Bullish nature of the market, I’m not interested. I still think stocks are overvalued in the face of economic conditions. I’ve been cash-heavy for a long time now and I will continue to be. I just don’t trust this market.

The big question in the back of my mind is "why." Why is the market so buoyant and positive? What does it see ahead that leads it to believe that the seeping ocean of debt, the lack of consumer confidence, continuing unemployment, and expansion of public entitlements will somehow all be overcome by an as yet invisible (to me anyway) robust economic strength?

Whatever the answer to "why", the market is being driven by
institutional buying which means the Wall Street experts think things are looking up. That jibes with Treasury Secretary Geithner's most recent comments that the Great Recession is over. This, in turn, has become yet another point of polarization between democrats and republicans in Washington over whether Bush-era tax cuts should be allowed to expire. Perhaps the stock market action has signaled that it approves of an end to these tax cuts in order to help offset the deficit. Or maybe the market approves of the fact that, in not renewing the tax cuts, the democrats may be shooting themselves in the foot.

Who knows what the Bull might have on its mind? All I know is that Dow Theory says the Bull will run for awhile now. Let's see how far and for what reason.

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