Look to the Dow for Leaders

The Dow Industrials topped out above 14,000 in October and dropped about 1,500 points into its January low. The index has since recovered about 600 points but is still mired in its worst downtrend since 2002. Despite the downturn, the Dow has one characteristic that's unique among the major indices: It's still trading in breakout mode.

The venerable index posted a major high at 11,750 in January 2000. It returned to that resistance level and broke it decisively in November 2006. Contrast this bullish action with the S&P 500, which sold off three months ago within 23 points of the major high it posted at the peak of the millennium bubble.

Dow Jones Industrials

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Source: eSignal

Why is this important? In sum, the Dow still shows a string of higher highs and higher lows on the long-term chart, a basic requirement for a bull market, while the S&P 500 is grinding out a massive double-topping pattern. This predicts that Dow stocks will outperform their blue-chip brethren, especially as long-term support near 11,500 kicks in.

In this regard, the Dow's January low at 11,634 is notable because it offers evidence that deep support is starting to show its broad influence. But we can't read too much into the exact price level of the bounce because it can take months for monthly support levels to kick into gear and turn a falling market to the upside.

When we look at the Dow chart in July or August, however, bullish price activity near this support zone should be obvious to the naked and untrained eye. So in the meantime, let's agree in principle that at least a handful of Dow stocks might start to show leadership, in preparation for the larger-scale turn, if and when it finally arrives.

Which are the best candidates to lead the Dow to higher prices? It's a tough question, because few index components are trading near new highs after the blitzkrieg of selling pressure of the last few months. However, recent turns off notable lows and early-cycle buying interest could blossom into full-blown uptrends sometime down the road.

McDonald's

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Source: eSignal

McDonald's (MCD - commentary - Cramer's Take) is a perfect example. The fast-food king posted an all-time high at $63.69 in December and sold off hard.

It violated 200-day moving average support right at the January turn and then bounced for three days before gapping down to the low after earnings. Buyers stepped in at that level and carried price to a three-week high on Friday.

This bullish action confirms a double bottom that could set the stage for a run back to the high in the second quarter. In the meantime, the stock has considerable work to do because the pattern shows resistance in the mid- to upper $50s, as well has lost sponsorship from its prior decline. It will take time to overcome both negative forces.

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Coca-Cola

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Source: eSignal

Coca-Cola (KO - commentary - Cramer's Take) is another Dow component showing the markings of a bottoming pattern. Like McDonald's, the stock sold off into long-term support last month and bounced with the broad market. It's held well above the low posted on that day, showing a rounding pattern that's consistent with a basing process.

The stock's relative strength is turning higher in both long- and short-term readings. This predicts that price will hold the lows for now and embark on a follow-through recovery that could reach the lower $60s. However, the best we can hope for in the next month or two is sequential progress that fills out the January selloff and draws in new investors.

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AT&T

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Source: eSignal

Now let's consider the fortunes of AT&T (T - commentary - Cramer's Take). The stock rallied to a six-year high in September and pulled back. It tested the high in late December and then sold off, breaking five-month support a few weeks later. That major violation lasted for six bars before price surged back above the contested level.

The stock has been testing this pivot point for the last two weeks and is holding up very well. This bullish activity is signaling a notable "failure of a failure" buy signal, which predicts a buying surge equal in length to the burst off the January low. That rally would take price back to the double top zone near $43.

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General Electric

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Source: eSignal

There isn't much to love in the General Electric (GE - commentary - Cramer's Take) pattern, but good things are happening under the surface. The stock rallied to a six-year high at $42.15 in October and entered a steep downtrend. It bounced with the broad market in January but progress since that time has been minimal, with price now trading just a point above the deep low.

However, accumulation-distribution readings are telling more bullish tale. Note how on-balance volume (OBV) posted its last low in December and started to tick higher. The indicator then surged at the January low and has held up much better than price. This points to institutional buying pressure that should lift the stock in coming months.

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At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

Farley is also the author of The Daily Swing Trade, a premium product that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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