PATTERN RECOGNITION...SPOTTING THE COMEBACK STOCKS
In 1884 Charles Dow published the first stock market average composed of the closing prices of
eleven stocks: nine railroad companies and two manufacturing firms. Dow felt that these companies
provided a good indication of the economic health of the country. Three years later, he determined
that two separate indices would better represent that health, and would help investors identify and
anticipate the business cycles and associated market patterns. Dow was a man of the sea and had
observed that waves and tides gave clues to the patterns inherent in stocks.
Technical analysis can help identify these patterns which reflect the psychology of the participants in
a stock or in an entire market. Think about how you feel when a stock you own falls in price. You
begin to wonder what's wrong and your confidence in the company's shares may erode as the price
continues to slip and slide. As educated unemotional bargain hunters know, the behavior of
investors at or near market bottoms provides many of the greatest buying opportunities you may
every have for building wealth. We'll examine several new Fallen Angel candidates in this Bulletin.
Watching Waves & Tides...Dow Obeserved that Major Trends Have Three Phases
Dow's genius was his development of a market barometer that continues to this day helping investors
to read market sentiment, and can be helpful for those who want to buy low and to sell high. He
focused his attention on three distinct phases: An accumulation phase, a public participation phase,
and a distribution phase. The accumulation phase represents informed buying by the most astute
investors, the bargain hunters. This is where we want to be with our Fallen Angel and rising star
stocks. If the previous trend was down, then at this point, smart investors recognize that the market
has assimilated all the so-called "bad news." The public participation phase is where most trendfollowers
begin to participate. This second phase occurs when prices begin to advance rapidly and
business news improves for a specific company or the entire economy.
Phase Two ...Builds Momentum and Velocity Like a Wave
By the time everyone wants in, the wave begin to peak before breaking, in what Dow called the
distribution phase. The distribution phase takes place when newspapers and magazines begin to
print increasingly bullish stories, when economic news is better than ever, and when speculative
volume and public participation increase. During this last phase the same informed investors who
began to "accumulate" near the bear market bottom when no one else wanted to buy, begin to"distribute" before everyone else starts selling.
Big Surf Coming...Watch the Transportation Averages!
The Dow Theory holds that when transportation company stocks (Dow Jones Transportation
Averages DJT) rise ahead of the industrial stocks (Dow Jones Industrials DJI) it signals that business
must be good for the manufacturers. The transportation companies that ship to the customers often
rise in price before the manufacturer's shares do. One of our Fallen Angel selections is a transporter.
One is a new economy play, and the other two are very big names currently out of favor.
- Norfolk Southern Corp. (NSC) around $25 to $26 with a price target of $35 to $40.
- Flextronics (FLEX) around $14 with a price target of $30, or even the old high of $40.
- Microsoft (MSFT) around $27 might make a run for the old 2000 highs around $60.
- Amgen (AMGN) around $55 ought to move back up to $75.
These four stocks have 50% upside at these levels. Remember that we do not provide sell signals in
the Bulletin, as this is reserved for our managed accounts only. Be sure to diversify, and take your
time buying these issues as they may fall even further before beginning the public accumulation and
participation phases.
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