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Dow Theory Gurus Weigh In

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Strategists warning of a near-term pullback in the stock market list their many reasons for hand-wringing.

To wit: market sentiment is tilted heavily toward the bullish camp, which from a simplistic contrarian perspective is bearish; a February flop for the market, as recently detailed by Minyanville, is not an uncommon historical event; and there have been some eye-catching non-confirmations.

Specifically, the Dow Industrials and S&P 500 Index have reached fresh highs. But the Dow Transports, stalled beneath their Jan. 13 closing high of 5,229.47, have not confirmed the move to new highs.

This divergence is worth watching. Under Dow 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. However, divergence between the two signals risk of a potential turn in the market's tide.

Still, Richard Moroney of Horizon Investment Services and editor of the Dow Theory Forecasts report, says that he’s still maintaining a mostly invested posture. Here are a few of his reasons:

- The Transports, after gaining 27% from Aug. 31 to Jan. 13, trade less than 3% below 5,229.47. Considering the risk posed by unrest in the Middle East and higher energy prices, says Moroney, the Transports have shown decent resiliency.

- The broad market is moving higher with the Industrials. With the exception of the Transports, he says, the market's reaction to December-quarter results has been encouraging. Advance-decline lines indicate most stocks have participated in this year's rally, and nine of the 10 S&P 500 sectors had year-to-date gains through Feb. 8.

- Moroney told clients that he continues to find attractively valued stocks supported by operating momentum and solid growth outlooks. The S&P 500 Index trades at 13 times expected 2011 earnings - a reasonable multiple relative to historical norms, he says. More important, many individual stocks trade at discounts to historical norms despite outstanding operating momentum.
POSITION:  No positions in stocks mentioned.