Three Fundamental Blunders That Led Me to Trend Following

 

How Misplaced Trust in ‘Expert’ Opinions Led Me to Embrace Technical Analysis

 

If you’ve been following me for a while, you know I firmly believe in trend following. I’ve learned that price action contains most—if not all—the information you need to succeed in the stock market (or any market, for that matter). But why did I become such a staunch advocate for technical analysis and skeptical of fundamentals?

It boils down to personal experience. I’ve learned the hard way that so-called “expert” opinions are often worth nothing. Today, I’ll share with you 3 fundamental blunders I made that steered me toward the Dow Theory, relative strength, and technical analysis in general. Thankfully, none of these mistakes were catastrophic—I didn’t bet the farm—but they were eye-opening. And while I’ve taken some creative license with the names of the companies involved, the lessons are real.

Blunder 1: The Canadian Paper Company (BW) – A “Value Play” Gone Wrong

Back in 2009, I bought into a Canadian paper company, let’s call it “BW,” which was touted as a classic value play. According to a well-known fund manager, Mr. T, BW’s land and timber holdings far exceeded its debt, making it an absolute steal. Despite the decline in paper demand, BW had supposedly secured its markets, and its assets were valued well above its liabilities. The story was compelling, so I bought in—despite the clear downtrend in the stock.

What happened next? BW filed for bankruptcy protection. Shareholders like me were wiped out, while creditors ended up with new shares when the company emerged from bankruptcy in 2010. In short, while the company survived and became leaner and more competitive, I was left with nothing. The “value” may have materialized for someone, but not for the original shareholders.

Lesson learned: value can be elusive and not be for you, and price action never lies.

Blunder 2: The Venezuelan Gold Mine – Don’t Trust Communists

In 2006, I attended a conference where one of the directors of a gold mining company—let’s call it “BrokenGlass”—touted their big find in Venezuela. As they claimed, it was a new “El Dorado,” and the stock was set to skyrocket once mining operations began.

I was skeptical. I raised my hand and asked the director if he wasn’t worried about Chávez nationalizing the mine. He reassured me they were in good standing with the government, building schools, and supporting local communities. But my instincts told me otherwise: “The f***ing Chavez is going to screw the Canadians up.”

Well, the honeymoon with the communists abruptly ended when, in 2008, Venezuela denied BrokeGlass a key environmental permit, effectively preventing the company from constructing the mine. Following this, Venezuela took steps to nationalize its gold mines.

By 2011, BrokenGlass’s stock had plummeted to just $0.10 per share.

Another hard lesson: political risk can’t be ignored no matter how compelling the story. The good thing is that I did “pass.”

Blunder 3: The Oil Exploration Company – The Slow Burn. Capital buried for almost 20 years and counting.

My third blunder is still unfolding, but the story is equally instructive. I invested in a private equity offering from a Cyprus-based oil exploration company that had secured drilling leases in Central Asia.

The investment was recommended by a former big-shot analyst of an investment fund. As usual, he said that given the proven reserves and proximity of the oil to the surface, this oil-drilling operation could be profitable even with oil priced at $20, and the oil and gas reserves were huge.

The deal looked too good to pass up. Proven reserves, favorable geography, and a projection of 20x returns made it sound like a sure thing.

There was an initial private offering at $1 a share. My friend and analyst said the company was worth at least $20 a share. He expected the company to go public around one year after the private equity placement, and we would cash out with an x20 gain.

Sounds great, isn’t it?

But nothing is ever that simple. A neighboring country contested the drilling territory, leading to years of negotiations. Then came the Ukraine-Russia war, which further delayed any progress. While the company has managed to scrape together enough funding to keep the lights on, we’ve yet to see a single drop of oil, while our original stake has been dilluted by the new issuance of shares.

Now, 17 years later, my friend—who originally recommended the investment—remains optimistic. He believes we might still get a decent return, but the opportunity cost has been enormous. Even if we cash out after 20 years with an x5 return, it would still be a mediocre investment for me, amounting to an 8.3% CAGR for a high-risk, illiquid asset. The Dow Theory and my timing indicators have delivered better returns while remaining liquid and minimizing drawdowns.

The lesson here? No one can predict the future, and sometimes, even when the fundamentals seem sound, the unknowns can derail everything. And even if I manage to cash out, the return will be mediocre compared to what I could’ve achieved by simply following the trends in the market.

Bottom line: Even the best explanation of an investment theme can go wrong. We must be humble (at least when investing) and accept that we are not omniscient. Well-crafted narratives do not necessarily translate into performance. You will be ruined or prosper by price action, not words. Or, as Ed Seykota put it:

“Fundamentals that you read about are typically useless as the market has already discounted the price, and I call them “funny-mentals”. However, if you catch on early, before others believe, you might have valuable “surprise-a-mentals”.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

Not so bullish now: Setup for a potential bear market signal for GDX and SIL completed

 The primary trend remains bullish until proven otherwise

Overview: GDX and Sil underwent a secondary reaction against the primary bull market. The recent price action resulted in a setup for a potential bear market signal being completed. Please mind the word “potential”, which implies that the primary bull market remains in force.

GDX broke up high but SIL’s weakness negated confirmation, and, thus, the bull market has not been confirmed.

Gold and Silver are in a bull market of their own, as I explained HERE.

General Remarks:

In this post, I extensively elaborate on the rationale behind employing two alternative definitions to evaluate secondary reactions.

SIL refers to the Silver Miners ETF. More information about SIL can be found HERE.

GDX refers to the Gold Miners ETF. More information about GDX can be found HERE.

A) Market situation if one appraises secondary reactions not bound by the three weeks and 1/3 retracement dogma.  

As I explained in this post, the primary trend was signaled as bullish on 4/3/24.

On 8/5/24, SIL broke down its 7/1/24 lows unconfirmed by GDX, so the primary bullish trend has not been changed.

The rally that started off the 8/7/24 lows set up both ETFs for a potential primary bear market signal. Thus, a confirmed breakdown of the 8/7/24 closing lows at 29.58 (SIL) and 34.71 (GDX) would signal a new primary bear market.

The table below gives you the most relevant information:

So, now there are two options:

1. If SIL and GDX surpass their 7/16/24 highs on a closing basis (Step #1 in the above table), the secondary reaction and setup for a potential bear market signal will be canceled. On 8/20/24, GDX surpassed its 7/16/24 highs unconfirmed by SIL. So, the technical situation has not changed.
2. A primary bull market will be signaled if SIL and GDX break down below their 8/7/24 lows.

The charts below illustrate recent price movements. The brown rectangles highlight the secondary reaction within the primary bear market. The small blue rectangles on the right show the initial days of a rally that set up both ETFs for a potential primary bear market signal. The blue horizontal lines indicate the last recorded primary bull market highs that must be surpassed to reconfirm the bull market (Step #1). The red horizontal lines highlight the 8/7/24 lows (Step #2).

As of this writing, the primary trend is bullish, and the secondary one is bearish.

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks and 1/3 confirmed retracement to declare a secondary reaction.

In this post, I explained that the primary trend was signaled as bullish on 4/3/24.

In this instance, the long-term application of the Dow Theory coincides with the shorter-term version, so there was a secondary reaction against the primary bull market and the setup for a potential bear market signal has been completed.

As of this writing, the primary trend is bullish, and the secondary one is bearish.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

From Indecision to Confirmation: US Bonds Show Clear Bullish Trends

 Exploring the Bullish Implications of TLT’s Recent Breakout

Overview: On 7/15/24, I wrote that there was indecision concerning the trend for US bonds. Depending on the time frame one got contradictory readings. You can get the details here.

The indecision is over. On 7/31/24, TLT (long-term maturity bonds ETF) surged higher, which has bullish implications in all time frames, as I will explain below.

Lower interest rates reflect lower inflation or a downturn in the economy. I think both. As my August 1^st Letter to Subscribers explained, I have solid economic reasons not to buy easily into the soft-landing narrative. Inflation will only go lower if the economy cools down.

So, let’s get started with the Dow Theory analysis.

General Remarks:

In this post, I extensively elaborate on the rationale behind employing two alternative definitions to evaluate secondary reactions.

TLT refers to the iShares 20+ Year Treasury Bond ETF. You can find more information about it here

IEF refers to the iShares 7-10 Year Treasury Bond ETF. You can find more information about it here.

TLT tracks longer-term US bonds, while IEF tracks intermediate-term US bonds. A bull market in bonds signifies lower interest rates, whereas a bear market in bonds indicates higher interest rates.

A) Market situation if one appraises secondary reactions not bound by the three weeks and 1/3 retracement dogma 

As I explained in this post, the primary trend shifted to bullish on 6/4/24.

On 7/1/24, a secondary (bearish reaction) against the primary bull market was signaled (you can find all the details of the secondary reaction here)

On 7/12/24, IEF surpassed its 6/14/24 primary bull market closing highs unconfirmed by TLT.

On 7/31/24, TLT broke up its 6/14/24 primary bull market closing highs and provided confirmation.

The table below gives you the relevant dates and prices:

The betterment of the last recorded primary bull market highs implies:

1. The secondary (bearish) reaction against the primary bull market has been terminated.
2. The setup for a potential primary bear market signal has been canceled.
3. The primary bull market has been reaffirmed.
4. A primary bear market would be signaled if TLT and IEF jointly violated their 7/1/24 closing lows. Presently, this is a very unlikely event.

The charts below give you a glimpse of the current situation. The red horizontal lines highlight the 7/1/24 lows, and the blue horizontal lines highlight the 6/14/24 bull market highs. The brown rectangles show the secondary reaction, which has been canceled.

Therefore, the primary and secondary trends are now bullish.

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks and 1/3 confirmed retracement to declare a secondary reaction.

As detailed in this post, the primary trend was signaled as bearish on 2/13/24.

In this post, I explained that a secondary (bullish) reaction against the bear market was in place.

A pullback followed after the secondary reaction bounce, setting up TLT and IEF for a potential primary bull market signal. You can get more details in this post.

On 7/11/24, TLT surpassed its 6/14/24 secondary reaction highs, unconfirmed by TLT. Absent confirmation, no new bull market was signaled.

On 7/31/24, TLT finally broke above its 6/14/24 secondary reaction highs, provided confirmation, and, thus, signaled a new primary bull market.

The table below gives you the relevant dates and prices:

The charts below give you a representation of the most recent price action. On the left, we see the bear market in action with lower prices until a secondary reaction (blue rectangles) interrupted the decline. Following the 6/14/24 secondary reaction highs, there was a pullback until 7/1/24 (brown rectangles) that set up TLT and IEF for a potential primary bull market signal. The blue lines highlight the secondary reaction highs, which were the critical level to be jointly surpassed for a new bull market. The red horizontal lines show the 4/25/24 bear market lows, whose confirmed violation would signal a new bear market.Therefore, we have the following technical situation:

1. The primary trend shifted to bullish.
2. The secondary trend is now also bullish.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

 

 

Will Small Caps Continue Outperforming Large Caps?

 

Understanding Small Cap Stocks in the Current Market

Will small caps continue outperforming large caps for a considerable time? Or have we just seen a flash in the pan? This is a question on many investors’ minds. While recent trends might suggest a resurgence of small-cap stocks, as shown by the chart below, the broader market dynamics hint at a different story.

 

I am convinced we are heading into a “winner-takes-all” economy, as Mark Hulbert (WSJ) has been suggesting since 2017.

Globalization and technology have created favorable conditions for mega companies like Apple, Amazon, and Facebook. These behemoths are leveraging their scale and technological advancements to dominate markets worldwide.

Even if globalization somehow unwinds, technology will continue to offer an advantage to tech-dominated global companies. The rapid pace of technological innovation ensures that large-cap companies with substantial resources can stay ahead of the curve, continuously improving efficiency and market reach.

Furthermore, the regulatory environment, which places undue compliance burdens on companies, clearly favors the big guy over the small guy. Large companies have the resources to navigate complex regulations, whereas smaller companies often struggle to keep up. So, I would not be surprised to see large-cap stocks outperforming their small peers for a long time. I am not saying that all small caps are doomed, but many will suffer.

The U.S. Advantage in the Global Economy

In the same vein as large companies, the USA is the country best placed to profit from the new normal. In fact, it has been taking the lead since at least 2009, as attested by the U.S. stock market performance vs its European peers. The U.S. has consistently shown resilience and earnings growth for shareholders, driven by its robust economic policies, innovation, and global influence.

I follow stock trends, but even more vital is to follow countries’ trends. Monitoring the economic health and policies of different countries can provide valuable insights into market movements and investment opportunities.

Key Takeaways for Investors

1. U.S. Market Attractiveness: Despite its challenges, the USA remains one of the most attractive destinations for capital. It is the “less dirty shirt in the laundry basket” by a long shot. I don’t buy into the thesis that Europe or Emerging markets are cheap. They are cheap for good reason: They lack earnings and have dire perspectives unless they dramatically change their economic policies.
2. U.S. Stock Indexes and Trend Following: Given that many U.S. (and world) companies are having and are likely to have a hard time in the future, stock indexes coupled with trend following to protect against the downside is my undisputable bet. What kind of trend following? Many trend-following systems are suboptimal and don’t stand scrutiny. The trend-following system must provide you with a track record spanning at least +20 years and have survived several bear markets. My trend-following systems boast a record starting as far back as 1953, so we can trade them with confidence.

3. Challenges in Stock Picking: If the future is probably going to be unkind to most stocks, most stock-pickers will suffer. What worked in the past (buy a diversified portfolio, hold it for a long time, and reap the reward) will no longer work. But don’t worry, as the saying goes, “there is always a bar full of people.” We can adjust our stock-picking strategy to meet the new normal. More on this in a future post.

For more insights into market trends and investment strategies, you can explore the detailed indicators and analysis available at The Dow Theory.

By focusing on these key areas, investors can better navigate the complex and evolving financial landscape, ensuring their portfolios are well-positioned for long-term success. The happy years of buy and hold are over.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

Gold and Silver ETF miners (GDX & SIL) soar: Primary bull market re-confirmed on 7/16/2024

 

Gold and Silver are also in a bull market

Overview: GDX and Sil underwent a secondary reaction against the primary bull market. Confirmed higher highs by both ETFs have reconfirmed the primary bull market.

Gold and Silver are in a bull market of their own, as I explained HERE.

I see most assets going to the roof. Are savvy speculators sensing that a wave of liquidity is going to be unleashed soon?

General Remarks:

In this post, I extensively elaborate on the rationale behind employing two alternative definitions to evaluate secondary reactions.

GLD refers to the SPDR® Gold Shares (NYSEArca: GLD®). More information about GLD can be found HERE.

SLV refers to the iShares Silver Trust (NYSEArca: SLV®). More information about SLV can be found HERE.

A) Market situation if one appraises secondary reactions not bound by the three weeks and 1/3 retracement dogma.  

As I explained in this post, the primary trend was signaled as bullish on 4/3/24. Following the 5/20/24 highs, both ETFs dropped until 6/13/24 (GDX @33.15) and 7/1/24 (SIL @30.9). Such a drop qualified as a secondary reaction against the bullish trend.

Following such lows, a strong rally ensued. On 7/11/24, GDX broke above its 5/20/24 closing highs (@37.24). On 7/16/24, SIL confirmed by surpassing its 5/20/24 closing highs @35.93.

So, the confirmed breakup above the last recorded primary bull market highs implies that the secondary reaction against the bull market has been canceled, and the primary bull market has been reconfirmed.

The charts below illustrate recent price movements. The brown rectangles highlight the secondary reaction within the primary bear market. The small blue rectangles on the right show the initial days of a rally that set up both ETFs for a potential primary bear market signal, which ultimately did not occur. The blue horizontal lines indicate the last recorded primary bull market highs that needed to be surpassed to reconfirm the bull market. 

Therefore, the primary and secondary trends are now bullish.

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks and 1/3 confirmed retracement to declare a secondary reaction.

In this post, I explained that the primary trend was signaled as bullish on 4/3/24.

In this instance, the long-term application of the Dow Theory coincides with the shorter-term version, so there was a secondary reaction against the primary bull market that has been successfully terminated by confirmed higher highs.

Therefore, the primary and secondary trends are now bullish.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

Bonds at crossroads: Contradictory setups completed imply the trend is now unclear

 Once hesitation is over, the next move can be explosive.

 

Overview: The bond market is really at a crossroads. Depending on the timeframe applied, we got two contradictory potential signals. The shorter-term application of the Dow Theory, which I favor in cases like this as it is more reactive, completed the setup for a potential bear market, while the long-term one resulted in just the opposite: a setup for a potential bull market.

Such a gross divergence between the two timeframes is infrequent. When it occurs, it shows a market lacking direction. When the bond market finally makes its mind up, the final move can be explosive.

Fundamentally, the bond market is caught between two contradictory forces: deflation and a likely recession and the underlying inflationary pressures, which, notwithstanding the most rcent CPI print, have not subsided yet, as evidenced by a rising Producer Price Index.

So, let’s get started with the Dow Theory analysis.

General Remarks:

In this post, I extensively elaborate on the rationale behind employing two alternative definitions to evaluate secondary reactions.

TLT refers to the iShares 20+ Year Treasury Bond ETF. You can find more information about it here

IEF refers to the iShares 7-10 Year Treasury Bond ETF. You can find more information about it here.

TLT tracks longer-term US bonds, while IEF tracks intermediate-term US bonds. A bull market in bonds signifies lower interest rates, whereas a bear market in bonds indicates higher interest rates.

A) Market situation if one appraises secondary reactions not bound by the three weeks and 1/3 retracement dogma 

As I explained in this post, the primary trend shifted to bullish on 6/4/24.

On 7/1/24, a secondary (bearish reaction) against the primary bull market was signaled. From its 6/14/24 closing highs, TLT and IEF dropped for 10 trading days, which satisfied the time requirement for a secondary reaction. The pullback also exceeded the Volatility-Adjusted Minimum Movement (VAMM, more about it here), so the extent requirement for a secondary reaction was also met.

Following the closing lows on 7/1/24, a strong rally ensued, setting up TLT and IEF for a potential primary bear market signal.

The Table below shows all the information you need:

 

 So, now we have the following options:

1) A primary bear market would be signaled if TLT and IEF jointly break below their 7/1/24 closing lows.

2) If TLT and IEF jointly break above their 6/14/24 bull market highs, the primary bull market would be confirmed, the secondary reaction extinguished, and the setup for a bear market signal canceled. IEF, has already surpassed its 6/14/24 highs unconfirmed by TLT. The longer it takes for TLT to confirm, the more suspect the breakup.

The charts below give you a glimpse of the current situation. The red horizontal lines highlight the 7/1/24 lows whose confirmed violation would signal a new primary bear market. The blue horizontal lines highlight the 6/14/24 bull market highs. The brown rectangles show the secondary reaction, and the blue ones show the recent rally that completed the setup for a potential primary bear market.

 So, now the primary trend is bullish, and the secondary one is bearish.

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks and 1/3 confirmed retracement to declare a secondary reaction.

As detailed in this post, the primary trend was signaled as bearish on 2/13/24.

In this post, I explained that a secondary (bullish) reaction against the bear market was in place.

After the secondary reaction bounce, a pullback followed, setting up TLT and IEF for a potential primary bull market signal.

The Table below shows all the information you need:

 

The charts below give you a glimpse of the current situation. The red horizontal lines highlight the 4/25/24 lows, whose confirmed violation would confirm the primary bear market. The blue horizontal lines highlight the 6/14/24 bull highs, whose breakup would signal a new bull market. The blue rectangles show the secondary reaction, and the brown ones show the recent pullback that completed the setup for a potential primary bull market. The grey rectangles highlight a pullback that did not meet the extent requirement to complete the setup for a bull signal.

Therefore, the primary trend is bearish, and the secondary one is bullish. 

Sincerely,

Manuel Blay

Editor of thedowtheory.com

Is the Dow Theory Misunderstood? The Truth Behind the Dow Transportation Weakness

 Secondary Reaction Highs (Lows): The Key to Market Confirmation

Recent weakness in the Dow Jones Transportation Average relative to the Dow Jones Industrial Average has prompted many “experts” to proclaim a bear market signal. They argue that new all-time highs by the Dow Industrials, unconfirmed by the Dow Transports, spell doom for the overall stock market.

Understanding the Dow Theory

Let’s clarify the concepts. Lack of confirmation means that one index makes a higher high (or lower low), and the other fails to break out. However, there is a common misconception about the Dow Theory. It’s often believed that if one index makes an all-time high, the other must also make an all-time high to confirm. This is not the case.

The Dow Theory, a cornerstone of stock market analysis, is based on the concept of secondary reactions. The top (or bottom) of a secondary reaction, which need not be an all-time high, is the relevant price level to be taken out. Thus, it can well happen that one index, like the Dow Industrials, makes an all-time high while the other takes out a minor high (a secondary reaction high). This counts as confirmation.

The Importance of Relevant Highs

Fixating on both indexes surpassing their all-time highs is not the right way to apply the Dow Theory. Most signals would be terribly late if we demanded “all-time highs” confirmation. Jack Schannep explains it beautifully on pages 39-41 of his book.

This post also gives a recent example of the relevant highs to focus on in seeking confirmation. While significant weakness in the Dow Transports when both the S&P 500 and Dow Industrials are making higher highs may be a yellow flag (as it was in October 2007 and December 1999), requiring all-time highs confirmation to enter the market leads to poor performance.

Thus, the lack of confirmation of a relevant high (not “all-time highs”) merely serves as a yellow light that may question the persistence of the current trend. It is NOT, as many purport, a signal showing a change in the trend.

Bullish Implications of Non-Confirmation

Furthermore, I will boldly assert that the Dow Transports’ lack of confirmation of an all-time high by the Dow Industrials is bullish. This is not just a claim, but a viewpoint supported by two studies.

The first study by Mark Hulbert  shows that the stock market performs better when the Dow Transports are lagging.

 The second study by Seth Golden shows that while the S&P 500 made a new 12-month high in the first half of the year unconfirmed by Dow Transports, it was notably higher in the second half of the year. The study confirms that “all-time” or “12-month highs” confirmations are not the proper highs to focus on when looking for confirmation.

 

Key Takeaways

Confirmation is essential when correctly applied: Focus on the highs (or lows) of secondary reactions, which in many instances are not the all-time highs. Lack of confirmation of such relative highs is a yellow flag (not a red one) with trading implications as they help avoid a sucker rally or a bear trap, as you can see in the following examples HERE and HERE, and a couple of weeks ago with Bitcoin whose breakup was not confirmed by Ethereum (a post on this non-confirmation that once again saved my skin will follow soon).

Conclusions

• When applying the principle of confirmation, identify the right highs (or lows) to be jointly taken out.
• All-time highs are not the right highs in many instances.
• Secondary reaction highs (or lows) are the right highs (or lows) to focus on in most cases.
• Lack of confirmation of a relevant high (or low) is not a Sell (or Buy) signal; it is simply a yellow flag.
• Lack of confirmation by the Dow Transports of an all-time high or even a 12-month high is actually bullish for the stock market.

Sincerely,

Manuel Blay

Editor of thedowtheory.com