Dow 14000 - The Pros Sustain the Close

Today the Dow Jones Industrial Average closed above the psychologically important 14000 mark. The last time that this number was in the news, it marked the end of a rally in the stock market. This time, it looks like the 14000 level will mark the beginning of a rally, rather than the end of one. As I stated previously in Dow 14000 - The High Water Mark?:

...when a market average such as the Dow passes through 12000, and then 13000, confidence and buying momentum build. And when the next much heralded number, 14000, becomes a barrier that the market can reach, but that the Dow average cannot close above, then that is a worrisome sign for the stock market.

The last time that the Dow average crossed the 14000 line, it closed below that number as traders rejected the new valuation for the 30 Dow stocks. Today, the Dow charged through the 14000 mark on high volume and closed above this number for the first time ever, providing a buying signal as strong as the sell signal that was provided by the rejection of this level last July.

And while we are taking a stroll down the (admittedly short) memory lane of previous columns posted to this blog, I should mention that the "festival of falling knives" that caused so many investors so much pain between the end of July and mid-September appears to be over. Only 40 companies had their shares hit new record low prices for last 52 weeks today, well down from the record of 1,107 new low prices which was set on August 16, 2007.

Certainly, investors have plenty to worry about, from fears of recession to the uncertainty that comes with a prededential election on the horizon, but for the moment we can take solace from a Federal Reserve that is apparently more eager to avoid a recession than to support the dollar or to contain inflation, and from a stock market which is rebounding from a substantial correction. Now is a good time to buy rationally priced assets, using the screen that I described in Avoiding the Pitfalls of Growth Investing, parts I and II, especially if you are investing with a time horizon of a year or more.

In my next column, I will discuss the reasons why you should hold your stocks for over a year, and why the shares of General Electric and Johnson and Johnson look so inviting at the moment.

Festival of Falling Knives: NYSE 52-Week Lows

When a company's shares trade at their lowest price in the last 52 weeks, it is a sign of pervasive fear among many of the holders of that company's stock. Because most listed shares trade hands several times a year, it means that most current holders of that stock are sitting on an unrealized loss. Their fear often leads them to more selling as their shares hit new 52-week low prices, which is one of the reasons that buying companies hitting new 52-week lows is often referred to by traders as "Catching a Falling Knife": because you can be badly hurt if you buy such a company and it's shares continue to fall.

Today's trading on the NYSE exchange was, therefore, a sort of "festival of falling knives": 351 companies listed on the NYSE had their share prices hit new 52-week lows - more than at any time in the last 3 years. Unlike the previous "festivals" of 200 or more new 52-week lows, which occurred on October 12, 2005 and June 13, 2006, this festival did not occur after a broad decline had already occurred.

At the top of the chart shown above, I have added a barometer which shows the percent of shares listed on the NYSE that are trading above their average share prices for the last 50 days ($NYA50R). Such 50-day moving averages are widely used by traders and money managers, and are often used as shorthand for the trend of a stock: if a stock is above the 50-day moving average, it is trending up; if it is below the 50-day moving average, it is trending down.

When this barometer shows that only 20 percent of the shares listed on the NYSE are above their 50-day moving average, the market has usually already sold off pretty well (to what is called an oversold condition), and is generally due for a rebound. The previous festivals occurred when this barometer was showing just such an oversold condition, as shown by the green circles in the drawing above. These festivals punctuated long bouts of selling that left most of the companies on the NYSE trending down, and marked the end of the down trends for many of those companies.

Today's festival, in contrast, occurred when 37.27% of the companies listed on the NYSE are above their 50-day moving average - nearly twice the number seen in the previous events. So, if recent history is any guide, the market may have further to fall, and this festival may be just the warm-up for a bigger event in the near future.

To investors with a long time horizon and a hard nose for value, such events provide buying opportunities. But for most investors and traders, a new 52-week low in a stock that they own is a very unwelcome event. And a festival of falling knives, occurring out of the blue, when the NYSE is not oversold, is a very ominous event, indeed.

Dow 14000 - The High Water Mark?

Last week, all eyes were on the next all-time record for the oldest and one of the most important barometers of stock market performance: the Dow Jones Industrial Average (or Dow Average), which was fast closing in the 14000 mark. The Dow Jones Industrial Average includes large established companies such as Boeing, 3M, and Disney; companies that are often bellweathers for their various industries. For this reason, many people watch the Dow Average to get a sense of the direction of the overall stock market.

Round numbers, in this case 14000, tend to function as "pivot points"; points that either provide resistance to further price increases, or, once surpassed, serve to support to prices when they pull back to that level. This behavior, in both individual stocks and in market averages, was first observed by Jesse Livermore, an innovative speculator of the 1920s. The reasons for this behavior have their basis in human psychology - people tend to anchor their attention on numbers that are easy to remember, and to make decisions based on the performance of share prices relative to those anchors. The effect of this anchoring is to cause buy and sell orders to cluster around round numbers, making these levels difficult to pass through unless the momentum of the market is particularly strong. Another effect of this "anchoring" behavior is that the media trumpets the arrival of each new round number (first 12000, then 13000, then 14000), drawing attention to the performance of the stock market, and drawing in more buyers.

So, when a market average such as the Dow passes through 12000, and then 13000, confidence and buying momentum build. And when the next much heralded number, 14000, becomes a barrier that the market can reach, but that the Dow average cannot close above, then that is a worrisome sign for the stock market.

The stock market is certain to cross 14000 sooner or later, but for at least the time being, the market is taking a breather, and a close above 14000 is most likely weeks away, in the opinion of this humble scribe.