As the Dow Jones Industrial Average (Dow) has closed lower two consecutive days, three of the past five days, and is less than two points above its 10-day moving average (MA), we can easily picture the late bulls gnashing their teeth as they worry about further declines and the bears smiling with delight as they envision more pain. On the surface, these emotions are logical. Glance over the events that have transpired since early February, and the news may have been slightly positive, but there is little to justify an 11% rally in less than two months.
From February 8 to April 5, the Dow finished higher 28 of 40 trading days (70%). In the process, my timing model moved from an oversold 20% long to an extremely overbought 96% long. Currently registering an 82% long reading, the broad market has raced higher while the average stock has digested its recent gains.
During this rally, all those who have missed the low on February 8 and never trusted the relentless move higher have been stuck on the sideline. Awaiting an overbought market's decline some will look at the past few days as vindication of their caution. Caution was warranted, but the important question is how to invest going forward.
An investor who saw the market finish higher 70% of the time and expected such frequent gains to continue indefinitely is misguided. Markets move both up and down and any investment strategy that cannot accommodate both is destined to fail. Therefore, as prices pull back we must ask ourselves if it is a reversal of the current rally with prices topping out or a consolidation before the rally resumes.
Agreeing with those who feel a decline is past due, the direction of prices is much less important than the magnitude of the move. I believe we are witnessing a mild consolidation and investors should be buying weakness.
A retreating Dow may garner headlines, but the bullish momentum of the broad market remains intact. This week has seen the French, Russian, and Australian markets finally hit new recovery highs and 13 of the 14 markets I track hit new highs on either Monday or Tuesday. This leaves China as the only market lagging the current strength.
Such synchronized movements are indicative of bull markets as investors look to own stocks across the spectrum. Fleeting rallies are characterized by a few, select stocks roaring higher as the average stock either stalls or declines. Conversely, powerful rallies see stocks moving higher in harmony as risk appetites increase.
Rarely will markets peak when stocks move higher together. Therefore, as prices stall, we should look to increase our equity exposure. Markets will always move in unpredictable manners, but following a disciplined investment approach that buys what is cheap, sells what is dear, and takes advantages of opportunities when they occur, increases our chance of success.