Dow Breaks Out: What Does It Mean For Investors?

By: Chris Ciovacco | Mon, May 12, 2014
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News Flow Was Light

Given financial markets have an almost infinite number of moving parts, it can be difficult to pin down why investor tone changes from one day to the next. Monday's big gains came on a slow news day. From The Wall Street Journal:

Shares of smaller companies, meanwhile, staged a recovery from their recent lows. Such companies have fallen out of favor in recent months as investors have flocked to shares of larger, more attractively-priced companies. The Russell 2000 index of small-cap stocks recently advanced 23 points, or 2.1%, to 1130, though it remains 6.5% off its recent high of 1208.65 reached in March. News flow in the stock market was light Monday, with the bulk of the earnings season over and little in the way of major economic data due in the session. Steadily improving economic data and better-than-expected earnings reports are helping to lift stocks, say traders and investors."The fundamentals of the economy are actually improving," said Brendan Connaughton, chief investment officer at ClearPath Capital Partners. "Inflation is not an issue. Valuations, although not attractive, aren't in bubble territory or exceedingly expensive."

$RUT Russell 2000 Small Cap Index INDX


Dow Clears Consolidation Hurdle

Regular readers know that sideways action in stocks is symptomatic of investor indecisiveness. The bad news is sideways action can be extremely frustrating. The good news is the longer stocks consolidate, the bigger the move (up or down) that typically follows. For example, fourteen months of frustration was followed by a 37% pop after stocks finally broke out in early 1995.

$SPX S&P 500 Large Cap Index INDX

Fast forward to Monday's session and we see little progress was made in the Dow Jones Industrial Average over the past four months (between points A and B below). The evidence says the period of investor indecisiveness may be coming to an end.

$INDU Dow Jones Industrial Average INDX

Monday's session was marked by wide participation (breadth), which tells us buyers had more conviction about positive economic outcomes than we have seen in recent weeks. From Reuters:

Gains were broad, with eight of the 10 primary S&P 500 sectors in positive territory. Cyclical groups such as materials and industrials ranked among the day's biggest gainers. The only sectors to decline were utilities and telecom, both considered defensive plays. About 77 percent of stocks traded on the New York Stock Exchange rose, while more than three-fourths of Nasdaq-listed stocks gained. Internet and biotech names were among the strongest advancers of the day.


Consolidations Can Be Resolved In Bullish Manner

A common question on Twitter in recent weeks has been:

"What do you think about the ongoing small cap underperformance?"

It is logical to be concerned when higher-growth companies are shunned by investors since it is indicative of increasing concerns about the economy, earnings, and Fed policy. However, as outlined with a historical example in this week's stock market video, there is no law of the markets that forbids a bullish resolution after an extended period of investor indecisiveness.


Video: Stocks: The Good, The Bad, And The Ugly


Investment Implications - The Evidence Will Guide Us

If you ask a weather forecaster how many days out they can somewhat confidently forecast the weather, the answer typically falls into the 5-8 day range. Then why are 10-day forecasts published on a regular basis? Answer: the public demands them. Just as a meteorologist is constantly revising their weather forecasts as the inputs change, we constantly assess the market's current risk profile based on the latest known information, using our market model. Is it possible that Monday's gains in stocks were the result of short covering? It is, but the fact that most of the gains carried into the close casts some doubt on the "this was just shorts covering" theory. Regardless, Monday was one day. Consequently, we added a relatively small position in industrial stocks (XLI) Monday to incrementally increase our exposure to growth-oriented assets. If the evidence continues to improve, we will adjust accordingly. Conversely, if Monday turns out to be a one-day wonder, we still have some offsetting defensive exposure to bonds (TLT).


Odds Have Improved A Bit

The takeaway from Monday's new high in the Dow is that the odds of good things happening in stocks are a little better today than they were last week. We think in probabilities, which allows us to (a) account for the possibility of a false breakout, and (b) remain flexible in terms of what may happen in the coming days. Tuesday morning brings an important report on retail sales.

 


 

Chris Ciovacco

Author: Chris Ciovacco

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.

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