Wednesday, July 1, 2015

Dow Theory Update for July 1: Dissecting the ongoing secondary reaction for US stocks





Is paper gold dying?



Yesterday, I warned that the secondary trend for stocks had turned bearish on June 29th (secondary reaction against the primary bull market). Please mind that I slightly depart from Schannep when it comes to considering “in the clear” signals and subsequent secondary reactions. More about this small discrepancy here and here.



Today I will give you some more details as to the ongoing secondary reaction. It has not been an easy one to discern. Therefore, this past post (which gauged the situation on June 11), may be helpful so that readers of this Dow Theory blog get the full big picture concerning the appraisal of the current secondary reaction.


Here you have the chart:

Orange rectangles on the right of the chart display the ongoing secondary reaction



On May 19th (blue arrow) the Industrials exceeded the last recorded primary bull market highs. The SPY did likewise on May 21st. Two higher confirmed closing highs served me to consider the primary bull market reconfirmed on that day, in spite of the lack of confirmation of the Transports.  From that date all three indices have declined more than three percent (which is the minimum extent requirement for a secondary reaction to be declared). The spreadsheet below displays the details:





 

Therefore, both the time requirement (more than 8 trading days of declining prices as the average for the three indices) and the extent requirement (more than 3% declines in at least two indices) has been met, and hence we can declare stocks under a secondary reaction.

From this point on, we have to wait for a >3% rally in at least one index. This would set up US Stocks for a primary bear market signal. Such a rally has not occurred yet. So we have to wait and monitor subsequent price action.

The primary trend remains bullish, as explained here and here.

GOLD AND SILVER

The primary trend is bullish as explained here.

The secondary trend turned bearish on February 6th, 2015 (secondary reaction against the primary trend) as explained here.

The setup for a primary bear market signal was completed on March 24, 2015 as explained here.


Thus, now:

a) Either the primary bull market closing highs 01/22/2015 are bettered in which case the primary bull market will be reconfirmed.



b) Or the  secondary reaction lows are violated in which case a primary bear market will be signaled.

We have to wait and see.

While I am no friend of “fundamental” analysis, it is stunning to see the lethargy of gold which seems unable to stage a decent rally even when global financial turmoil (Greece, Puerto Rico, drums of war, etc.) seems to be engulfing us. This has prompted Barry Ritholtz, of “The Big Picture” blog, to deride gold by quite rightfully saying that “Gold can’t find a Bid”. From a technical point of view I agree that gold (and silver even worse) looks weak. The secondary reaction against the primary bull market is lasting too long, and technically, supply seems to hold the upper hand. My only “fundamental” contention (so please take it with a healthy dose of skepticism) is that maybe what we see is the upcoming death of “paper” gold, which, according to renowned blogger FOFOA, is quite different from “physical” gold. If according to “free golders” (those that follow the tenets expounded by Fofoa, Foa and Another) “paper” gold is doomed (but physical gold isn’t), then what we see on the charts merely reflects the painful agony of a monetary system based on the USD and paper gold (as a prop for the USD). While being utterly skeptical of all fundamentally-based explanations of reality, if I a had to choose one concerning the future of the monetary system, gold, etc., I’d take Fofoa’s, and this is a big compliment to him coming from a dye-in-the-woods technician. More about Fofoa and his insights here.


GOLD AND SILVER MINER'S ETFs

 
As to the gold and silver miners ETFs,on 3/10/15 SIL violated its 12/16/2014 primary bear market closing low. However, GDX did not confirm. As per the Dow Theory lower lows unconfirmed have no validity, and hence we cannot declare a primary bear market. Since we cannot declare a primary bear market, the primary trend remains bullish. Furthermore, the GDX and SIL staged a rally that set them up for a primary bear market signal on March 24, 2015 as explained here.


Thus, now:

a) Either the primary bull market closing highs 01/20/2015 are bettered in which case the primary bull market will be reconfirmed.

b) Or the secondary reaction lows (or the primary bear market lows of SIL, and secondary reaction lows of GDX) are violated in which case a primary bear market will be signaled.

Once again, we have to wait and see.

US DEBT

As to US debt, a primary bear market signal was signaled on June 3rd, 2015. All price action from June 3rd remains bearish, and hence both the primary and secondary trend for US debt remains bearish.

Furthermore, the brand new primary bull market for the EUR is no good omen for US debt. The primary and secondary trend for the EUR (and CHF) remains bullish.

Here you have the details:


By the way, Barry Ritholtz has rightfully noted the inability of gold to stage a decent rally even amid financial turmoil. However, I also note that US debt has been unable to convincingly rally under equally favorable circumstances for alleged "shelters", which seems to tell us that there is inherent weakness in US debt. What we know for sure, is that US debt is in a primary bear market, and hence, the odds favor lower prices in the days and weeks ahead.

The chart below shows the last primary bear market signal and how US debt has been unable to stage even a decent “death cat bounce”.


US Debt: Primary bear market


Sincerely,

The Dow Theorist



Tuesday, June 30, 2015

Dow Theory Update for June 30: Secondary (bearish) Reaction for stocks since June 29





No time now for deep explanations, which will come tomorrow, if time allows.

Take my word: The secondary trend for US Stocks turned bearish on June 29.

Sincerely,
The Dow Theorist

Monday, June 29, 2015

Dow Theory Special Issue: Maximum Drawdown and average returns for the Dow Theory versus buy and hold





Trends remain unchanged.


This post is the detailed answer to one question posed by a follower of this Dow Theory blog. Hope it will serve Algyros and other readers to further a deeper understanding of the Dow Theory.

 Here is question:


"I was wondering if you had CAGR and Max DD backtested information for your flavor of the Dow Theory for a meaningful expanse of time. I hesitate to ask because I imagine that this information is somewhere in this blog, but, I've not succeeded in unearthing it."

And here is my answer:

Hi Algyros,

I am quite leery as to CAGR and such measures, as markets and future performance are not so easily tamed by past performance figures. Furthermore, the Dow Theory is a process, and hence, its practitioners should perform their own calculations. A figure such as CAGR means nothing, if the investor has not fully apprehended the intricacies of the Dow Theory. The courage to stick to the Dow Theory when there is an under performing spell, and there are many as I explained here, will come by fully internalizing the Dow Theory, not by its “dry” performance figures. Thus, rather than just looking at a CAGR figure, it is much more important to understand how fared the Dow Theory during secular bear markets, during past market crashes, and the like. Averages such as CAGR are misleading, and I feel it is more important to focus on the market traps that inevitably we’ll have to confront sooner or later. 

Having said this, I can give you the following information:



a) Here you can find a comparison of “buy and hold” versus Schannep’s Dow Theory. I created the charts and calculations using TradeStation®. You find the details enabling you to calculate CAGR in the link I have provided. Since the start capital for the simulation was USD 100 K, you can by yourself derive the CAGR made by Schannep’s Dow Theory versus the CAGR of buy and hold. Please mind that dividends have not been considered. More information as to Schannep’s out performance, in his master book “The Dow Theory for the 21st Century” and his website “thedowtheory.com”.



b) From the link I have provided, you can see that the deepest drawdown was caused by a string of three consecutive losses for a total loss of -19%. I insist you can download on Schannep’s site his Dow Theory track record so that you get the details of each signal (or you can find them in his book as well). By contrast, “buy and hold” had to endure three times drawdowns in the vicinity of -50% (in the seventies, 2000-2002 and 2008-2009)

c) Nobody knows whether the Dow Theory will encounter in the future a longer string of losing trades, thereby causing “death by a thousand cuts”. What would happen if the Dow Theory were to find six consecutive losers (something which hitherto has never occurred)? Well, knowing that (a) the average loss for Schannep’s Dow Theory is in the vicinity of -6.5% (why?: here), we could extrapolate that under a spell of very bad luck, the Dow Theory could endure a drawdown of ca. 30%-39%, which remains well below buy and hold (and furthermore, the likelihood of its ocurrence is more remote than for buy and hold, since we can see that in ca. 60 years buy and hold has declined more than 50% three times, whereas this has not happened one single time when following the Dow Theory). This is not a bad assumption. Traders say that “your worst drawdown is always ahead of you”, and, hence, in the very long run, it is likely that the hitherto made worst drawdown is going to be exceeded. Furthermore, another assumption of traders, is to just double the hitherto realized worst drawdown to estimate your worst drawdown in your career. Thus, if we take the hitherto worst drawdown of ca. -19% and double it we get -38%. Please mind, that these are just approximations. Nobody can predict the future, and we are at the mercy of the markets. However, we have reached a similar figure of the worst "likely" draw down we could encounter in the future by performing two different calculations.


d) To fully apprehend why Schannep’s Dow Theory outperforms buy and hold by ca. 4%, and, more importantly, when and why such outperformance occurs, I encourage you to read this study:



The issue of draw downs is a very important one (this is what traders refer as "risk of ruin") and it pertains to extrapolating what the future has in store for the Dow Theory. I am cogitating a future new saga of posts which would bear  roughly the following name: "Putting the Dow Theory under stress-test". The past +115 years have been, after all, very lenient for US stocks. How would the Dow Theory fare under radically adverse market conditions? I have studies of the Dow Theory performance under secular bear markets (which remains positive and with contained drawdowns), and hence we can get a foretaste of the looks of adverse market conditions. However, what I have in mind for my test is even more adverse market conditions. How would the Dow Theory perform if we were to encounter 10 years with an average decline of -7% annual? What if the economy enters a deflationary spiral of -5% p.a. with real GDP contraction of -4% p.a. during ten years? Would the Dow Theory scape unscathed (buy and hold wouldn't)? Which market conditions would result in 10 consecutive losing trades? Is the Dow Theory inherently protected against such a string of 10 consecutive losers (I feel "yes")? Why? All these are questions that hopefully I plan to write about in the future (If time allows).

Sincerely,

The Dow Theorist.

P.S. In spite of all market volatility with Greece, etc.,  primary and secondary trends remain unchanged for US Stocks, US debt, Gold, Silver, and their miners ETFs. As to Chinese stocks, they are immersed in a secondary bearish reaction against the primary trend, but have not set up yet for a primary bear market.