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Bull Market Confirmed by Dow Theory

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Adherents to one of the oldest market timing systems have reason to buck with optimism.

Specifically, the Dow Industrials and Dow Transports reached fresh multiyear highs on Feb. 11 and again on Feb. 16, reconfirming the bullish primary trend under the Dow Theory.

Under this theory, when both the Transports and the Industrials are moving together, hitting new highs at about the same time, the bull market is likely to continue. Divergence between the two would signal risk of a potential turn in the market's tide.

“While the reconfirmation does not preclude a pullback, it does signal that such a correction should be viewed as a buying opportunity,” says Richard Moroney of Horizon Investment Services and editor of the Dow Theory Forecasts report.

Of course, the strategist notes, a bull-market confirmation does not reduce the probability of a near-term decline. In fact, the market, he says, has been waving some yellow flags of caution.

For one, market sentiment remains frothy. A recent global survey by Merrill Lynch indicated that fund managers are more bullish toward stocks than at any time in the past decade. Historically, such a high level of bullishness has often been a precursor to a market pullback.

Technicals also signal possible trouble ahead: At 79%, the percentage of NYSE stocks trading above their 200-day moving averages is high relative to historical norms. Historically, a percentage above 70% has signaled an increased risk of a correction.

However, Moroney argues, trying to time short-term market zigs and zags with precision is a fool’s errand, in his opinion, and the most important signal of recent weeks was the Feb. 11 move to confirmed new highs.

“Moreover, with earnings growing and price/earnings ratios in line with historical norms, the year-ahead outlook for U.S. stocks remains favorable,” he says.
POSITION:  No positions in stocks mentioned.