Dow Theory special issue: After the dust has settled. Weekend commentary to the Dow Theory primary bear market signal

Putting things in perspective

Well, we are some hours after the close heading into the weekend, and it is a good time to assess the stock market action and primary bear market signal issued by the Dow Theory.

You can find in this post of this Dow Theory blog the basic information concerning the Dow Theory primary bear market signal.

You may find also useful the post “Is the primary trend for stocks about to change?” where I give additional background about the Dow Theory primary bear market signal.

Here you have an updated chart that illustrates the current juncture:

Disecting a primary bear market signal

I would like to make some additional comments that may be useful to investors.

Let’s begin by assessing how fared investors who followed the primary bull market signal.

As you can read here a primary bull market signal was signaled for stocks on June 29.

  

The entry point was at 136.1 for the SPY.

The exit point was signaled on Nov 16. The SPY closed at 136.37.

So, before commissions and slippage, those that invested along the primary trend, would have realized a gain of 0.20%.

Of course, some investors will feel disappointed.

However, it is necessary to put things in perspective.

First of all, we must bear in mind that the empirical +100 years track record of the Dow Theory shows that ca. 70% of the primary bull market signals end up in profits. This implies that 30% of the signals end up in losses. Losses are the operating cost to the investor. Those unable to bear losses should quit investing altogether.

So, in spite of the meager 0.20% profit, one thing is clear. Even factoring in slippage and commissions those that invested in the SPY (which is what I recommend to the unsophisticated investor) would have protected their capital. Investors should not forget that rule number one is to protect capital.

Thus, in spite of a failed primary Dow Theory signal, those following the Dow Theory have not been decimated. They have been able to keep their powder dry. Being in cash now shouldn’t burn a hole in their pockets.

And I just wrote “failed” Dow Theory signal, because we know that on average Dow Theory primary bull market signals tend to last more than 1 year. So, having lasted our bull market signal less than 4 months, this bull market died young, it didn’t even reach middle age.  It just lasted from June 4 (date of the last primary bear market lows) until September 14, date of the last jointly recorded highs. Thus, in spite of the modest, token profits, it is for me a failed signal.

Secondly, it is good to bear in mind that the initial stop level was set at the primary bear market lows of June 4 which resulted in a potential loss of 6.25%. While this figure is not carved in stone, it gives us a good measure of our worst case scenario under Dow Theory. As you can see, the ongoing market action managed to get us out on a timely manner fully unscathed well before the “worst case scenario”.

So even in seemingly times of adversity, I feel that the Dow Theory has done a good job in protecting capital.

Let’s move on to another aspect:

How much has lost the SPY since its market highs of 09/14/2012 at 147.24?

Here is the answer: -7.38%.

I feel few timing systems can beat the Dow Theory when it comes at being responsive. A loss from the top of just 7.38% implies very good timing. Please bear in mind that official lore says that a bear market is signaled when stocks have gone down by 20%.

How long is supposed this new primary bear market to last?

Rhea wrote in 1932 that:

“there is no known method of forecasting the extent or duration of a primary movement”

Thus, anything can happen. It may be stillborn (if the market stages a powerful rally off these lows as happened on June 4) or it may last one or even two years. Nobody knows.

What we do know, however, is that being invested in stocks when a primary bear market has been signaled will more likely result in losses than in gains. The empirical record of all signals since +112 years attests to this.

We do know something, though. While we do not know how long this bear market is going to last, we know from past experience that primary bear markets last on average 6.2 months after the primary bear market signal has been flashed. We, investors, are indebted to Schannep for his research on this matter, which is freely available under on his website “thedowtheory.com”.

If you go to the link I gave you, you will see that a bear market may last as little as a few days or more than 20 months. In any instance, don’t argue with the bear and get out of the way.

How deep is supposed a bear market to go?

Again we have no way of knowing beforehand. But if history is to serve us as a guide, Schannep states that the average decline after the primary bear market signal averages 14.8%. But don’t get fooled by averages, a bear market can entail losses exceeding 30, 40 and even 50%. So again, my piece of advice is: Don’t argue with the bear!

What should an investor do?

As it is written in the disclaimer at the footer of this blog and the additional disclaimer I post on specific important posts, I am not a financial advisor, and I am not engaged in advising people. This blog merely serves an intellectual pursuit and hopes to get people thinking about the market.

Personally, my line of thought is as follows:

·        For medium and long term positions (i.e. anything lasting more than a few days) I would be out of stocks completely. No questions asked.

·        Since the Gold/Dow ratio is clearly bullish and in favor of gold, I’d use some of the cash to purchase some gold. More about the Gold/Dow ratio and what makes me favor gold over stocks here  

 

·        However, being gold also at risk (a primary bear market may be signaled soon) I’d only make a small commitment. I’d favor cash.

·        You have to know your time frame and the kind of gold you want to buy. Not all gold is created equally and hence you should read this post here   

·        Those that are able to extract profits off the market with short term trading may continue trading stocks (being long) provided: (a) they know what they do, (b) have predefined stops and exits and (c) if possible adjust their strategy settings to a primary bear market condition (i.e. by demanding less powerful rallies when selling into strength).

Conclusions:

·     In spite of today’s primary bear market signal, those invested under Dow Theory have managed to keep their powder dry.

·     The Dow Theory, again, has been able to keep losses short and even secure a modest nominal gain.

·     A bear market has been signaled at less than 8% off the market top. This is certainly excellent timing.

·     All medium and long term investors should at the very least sell down or get out completely of stocks.

·      For those without gold exposure, a modest investment in gold may be considered.

Have a wonderful weekend.

Sincerely,

The Dow Theorist.

Disclaimer: Dow Theory Investment and its author is not a financial adviser. Dow Theory Investment and its author does not offer recommendations or personal investment advice to any specific person for any particular purpose. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of the footer of this blog.