Monday, September 24, 2012

5 Reasons why I consider the stock market in a primary bull market

Restating the bullish case as per Dow Theory among pervasive bearishness

Today I became more convinced than ever of the motto “bull markets always climb a wall of worry”. Most of the commentators are outright bearish. Some of them on a fundamental basis (“the world is going to end”, “QE will further destroy the economy”, “market guru Mr. So and So says the stock market will plunge”, etc), others on a technical one (“the market is overbought”, “the Transports are diverging”, etc.), argue that being bullish under these set of circumstances is clearly wrong.

But what tipped the scales today in favor of restating the bullish case for the stock market and also for the gold and silver markets has been an article that appeared today in Seeking Alpha. The article is written by Cam Hui, an investor whom I respect. The article was entitled “Not time to get nervous (yet)” and contrary to its title it really got nervous many investors if I am to judge by the comments made to his article.

You can find his excellent article here:

Cam Hui “bullishness” was mostly bitterly criticized by readers. Bearishness is deeply entrenched. Thus, I felt it was necessary to briefly restate the bullish case to assuage my readers. 

I know Dow Theory is not math. Thus, every market call is subject to the personal interpretation of the Dow Theory. It  is something similar to the practice of laws. While the laws are always immutable,  their application changes depending on the lawyer, the judge and the weighting of evidence. I hope to be a "good" lawyer when it comes to appraising the current condition of the market.

I feel the market is in a primary bull market (that is a long upward movement whose median duration is 2.5 years and may witness price gainst of 40% or more). because of the following reasons:

1. On June 29, both the SPY and the Industrial (so we had confirmation of two indices) signaled a primary bull market in stocks. You can find more details as to this bull market here

2. On Sept, 13, the Transports pierced the highs made in the preceding secondary reaction, thus also confirming the bullish signal of the Industrials and SPY. You can fin the relevant chart commented here. Even though, on Sept 21, the transports violated their last significant low, according to strict Dow Theory this was not a bear market signal. In my post of Sept 21 I explained the following:

The Transports violated today the last significant low (which was the lows made on 07/25/2012 at 4934,00). Today the transports closed at 4910.85. However, such violation of a significant low was not confirmed by the Industrials or the SPY. A basic tenet of the Dow Theory is that a movement unconfirmed by other index is meaningless.

Therefore, under Dow Theory, the primary bull market continues in force until a primary bear market signal is given. Since the SPY and the Industrials are still very far from their significant lows (which are the last bear market lows made on June 4), it seems unlikely that any such confirmation will be given. In other words, in spite of all the noise that you are likely to hear in the media and internet, the primary bull market continues in good health.

Furthermore, in my “Dow Theory Update for Sept 20” which you can find here I wrote about the weakness of the Transports and precisely the bullish implications it might have: 

Furthermore, Dow Theorist Schaefer provided us with a valuable insight concerning the Transports. Schaefer said that in the early stages of a primary bull market the transports tend to show relative weakness because among investors the prevailing mood is still bearish and hence the money flows to less speculative issues like the Industrials. The Transports tend to catch up when the investor’s mood turns bullish and a “risk on” more speculative mentality prevails. Of course, this doesn’t happen in a young bull market (as it is ours, only 3 months and 2 weeks old) because bull markets always start by climbing “a wall of worry”.

Thus, curiously enough, the Transports action might be hinting us what we already know: That most investors are skeptical about this bull market. Schaefer added that when the Transports turn really strong and the Industrials do not confirm, this tends to be a sign of an impending top.

3. The overall assessment of volume has been bullish. In spite of all the talk about vanishing volume, it has been very constructive in the last days. Up days with higher volume and down days with lower volume (exception last Friday) which is always bullish short term. Besides,  the trend line of volume also confirms market action.
But the skeptical reader might be saying: "All this is fine and dandy but there is a renowned Dow Theorist that insists that divergence of the Transports is bearish and, furthermore, we are in a bear market" Other readers might be thinking: "QE is going to destroy the economy so all this talk of the Dow Theory Investment blog will be proven wrong".

One of the tenets of the Dow Theory is that the theory is not infallible. However, the good thing of the Dow Theory is that it provides us with stops. So, even when proven wrong, losses are very contained and hence the investor keeps his powder dry. 

So, now comes the fourth reason that makes me bullish and that tips the scales in favor of accepting without second guessing the primary bull market announced on June 29 by the SPY and the Industrials. 

4) On June 29, the Dow Theory gave us with one of the best primary bull market signals ever. Let's look at it in detail. The bear market lows for the SPY were recorded on June 4 at 128.1. the bull market signal was given on June 29 at 136.1. Such bar market lows (and until we get a full secondary reaction) are our "stop loss" as per Dow Theory. If you do the math, the stop lies 6.25% below the entry price. So it is a very narrow stop. We know form Dow Theory that primary bull markets tend to witness a price gain of 40% or more. While nothing is carved in stone, we are talking about overwhelming odds of making 40% against losing 6.25% if things go wrong. So we are talking of a risk reward ratio of 6-7 which is an excellent one. 

In other words, with a worse risk reward (i.e. because we had had a belated Dow Theory signal with more ample stops at, i.e. 12%), then I might be more skeptical (or I might have suggest taking a reduced position). However, we had a very good set up on June 29.We stand to gain 40% whereas we may lose 6.25%. You can find more about the Dow Theory stops, the risk reward ratio, etc. here

With such a good risk reward ratio I give the benefit of the doubt to the Dow Theory, in spite of the weakness of the Transports, although, I insist again, we got a full-fledged-qualifications-free primary bull market signal on June 29. For a bull or bear market signal to exist, it is not necessary that the three indices confirm. With two of them confirming is enough.

5) Finally, the 200 day moving average of the SPY has an upward slope and price action occurs above the trendline. This is always a bullish sign (just additional piece of evidence).

Therefore, when I weight all the evidence I conclude again that we are in a primary bull market.

The way I see things it is not of about being right (Cam, I and other bulls may be proven wrong), it is a question of finding good setups with good risk reward, placing technically effective stops (which I put under Dow theory) and relax. No ego involved.

I hope this post is useful to you.


The Dow Theorist.

No comments:

Post a Comment