Now that the Dow Jones Transportation Average has broken above key resistance to new all-time highs, it is important that the Dow Jones Industrial Average stages a similar breakout to confirm the bullish trend. This confirmation relationship is a key principle of Dow Theory. A break above 16,588.30, or preferably above long-term trend line resistance at 16,610 would do just that.
If it turns out, however, that the Industrials do not breakout and confirm the path of the Transports, the resulting divergence could trigger the much-anticipated correction that many investors have been expecting or even hoping for.
Nevertheless, many signs continue to show that the economy is in good shape and is growing at a slow, but steady pace in the 2%-to-3% range. Fewer layoff plans by businesses and a general decline in weekly jobless claims add to optimism that 2014 could prove to be another good year.
With earnings season at hand however, there have been a number of corporate earnings reports that have thus been considered to be lackluster. One common theme seems to be the absence of top line revenue gains with stepped up cost-cutting efforts instead underscoring the current profit picture. In light of this and the tapering plans of the Federal Reserve, any hint of a stall in economic growth could result in a period of increased volatility.
The Fed has maintained that policy decisions going forward will be data-driven. As a result, this earnings season could hold a good deal of sway with investors, the averages and the Federal Open Market Committee. Interestingly, a period of increased volatility, if it were to emerge, might send investors back into the fixed income markets and blunt the recent rise in interest rates. Such an outcome would likely be a plus for the housing market and for housing stocks.
At the moment, inflation is low, U.S. dependency on imported oil is diminishing and the employment picture is improving. Couple this set of circumstances with the fact that many investors remain under-exposed to the equity markets and a positive long-term outlook begins to emerge. Thus, any near-term setback in equity prices, even if it is sharp, might present an interesting buying opportunity.
Jim Donnelly, Olson Global Markets