Part IV. Performance comparison under secular bull markets.
Until now
this series “Face off: Schannep versus “classical”
Dow Theory has focused on comparing Schannep’s and “Rhea/classical” Dow Theory
irrespective of the secular condition of the market. In part I we set out the
premises of our study (so that we conduct an apple to apples comparison). In
parts II and III we provided a wealth of data concerning both Dow Theory
“flavors”. However, until now, the results of our analysis did not differentiate between
secular bull and bear markets.
The
secular condition of the market does matter, though. Positions taken under secular bull
markets tend to last longer and be more profitable than trades taken under
secular bear markets. By secular market, I mean a market condition that spans
many years, which goes beyond the 1-3-year
duration of cyclical bull and
bear markets. Dow Theorist Schaeffer wrote that secular markets could last up
to 14 years. While I am reluctant to put a limit to the duration of secular
bull and bear markets, one thing is certain: they last more than cyclical bull
and bear markets and clearly influence the outcomes of the trades taken along
cyclical bull and bear markets. However, determining secular bull/bear market
conditions is not an easy feat on real time. It looks simple when looking at
charts ex post facto (after the fact).
Unlike spotting cyclical bull and
bear markets, which, under Dow Theory, is done with the exclusive aid of price
patterns, determining the secular condition of the market is not an easy feat
on real time, since it entails determining value. And “value” determination is
far from easy.
As I have
written here:
“While
classifying secular bull and bear markets is always subjective, there are some
guidelines like “q” “PER” or dividend yield, which may come in handy. In a
nutshell, secular bull markets start when stocks are very good values. While
determining value is always elusive (and this accounts for my being interested
in cyclical bull and bear markets
with an average duration of less than 2 years), we need a frame of reference.
Personally, I am skeptical as to PER and dividend yield for reasons to be
explained in a future post on this Dow Theory blog. However, having read, and,
more importantly, digested, Smithers and Wright book “Valuing Wall Street”
(which you can buy here), I personally feel that the “q” ratio a quite
dependable measure of the cheapness or dearness of a market on a secular basis.
Financial
writer Doug Short, whom I respect, has recently updated the “q” ratio as you
can read here. According to him “q” is currently overvalued, which
implies that it is likely that we are still mired in the secular bear market
that began in year 2000.”
The longer
the life-span of a trade, the more important fundamental and value
considerations are. If you are day-trading, earnings, business prospects, etc,
play no role in forecasting the stock’s price in the next five minutes.
Technical considerations (and significant randomness) are the overriding
factors. However, if you lengthen your time horizon to, let’s say, 10 years,
fundamental and value-based consideration will prevail and technical analysis
will pale by comparison.
Dow Theorist
Schaeffer, and to some more nuanced extend, Richard Russell, of the "Dow Theory Letters" advocate in favor
of investing along the secular trend. Rhea, Schannep, of "TheDowTheory.com" and this blogger truly
yours feel more comfortable investing along the cyclical bull and bear markets
that occur within the secular trend for reasons to be given in a future post on
this Dow Theory blog. Since, by definition, cyclical bull and bear markets have
a shorter duration than secular trends (let’s put it at 1-3 years), the
technical condition of the market plays a greater role in determining the
outcome of any given trade. Accordingly, the Dow Theory rules are a valuable
tool (in my opinion, the best one) to determine the trend on a cyclical (1-3
years basis). Nonetheless, the secular condition of the market, as a distant
but powerful tide, affects the profitability of the cyclical bull markets.
A secular bull market puts the very long term tide in your favor. This is why
it is important to try to ascertain the secular condition of the market, even
though one is not interested in investing along with it.
All in all,
both Schannep’s and the “Rhea/classical” Dow Theory generate trades which
exploit cyclical bull markets. Neither “flavor” attempts at investing along the
secular trend. However, the secular trend affects the outcome of the trades
taken along cyclical bull markets, and, hence, it makes sense to, albeit
tentatively, be able to determine the secular condition of the market. The
secular condition of the market will be “head” or “tail” wind, and, thus, it is
not to be neglected.
While
defining “secular” bull and bear markets is subjective, I have tabulated the
following periods:
From 1954 to
1967: SECULAR BULL
From 1968 to
1981: SECULAR BEAR
From 1982 to
2000: SECULAR BULL
From Mid 2000
to now: SECULAR BEAR.
Well, after
this lengthy, but necessary introduction, let’s start with our analysis of the
transactions taken under secular bull
markets.
Schannep versus Traditional
Dow Theory vital statistics (secular bull markets)
Total number of transactions (trades) taken:
Schannep:11
Classical:10
Comment:
When secular market conditions
are propitious, Schannep’s Dow Theory flashes almost the same number of signals
than the “Rhea/classical” Dow Theory. So much for the accusation of Schannep’s
Dow Theory being too restive. From this figure, we can deduct that the slightly
higher activity of Schannep’s Dow Theory (more trades) takes place when most
needed: When a secular bear market results in many aborted cyclical bull
markets. When there is headwind, more transactions are the antidote against
being caught in a monstrous drawdown. More about this when we analyze Schannep’s
performance under secular bear markets. However, when there is tailwind
(secular bull market), Schannep’s Dow Theory is as calm as the “classical” Dow
Theory.
Average duration of each transaction:
Schannep: 864 days.
Traditional: 856 days.
Comment:
This is
astounding. If you have been following this “face-off” series, you know than
when the secular condition of the market is not taken into account, the average
trade duration for Schannep’s Dow Theory was ca. 24% shorter than the average trade
duration for the “classical” Dow Theory.
Now we see
that when we zero in on secular bull markets, the average duration of each
transaction is actually longer (albeit
marginally) for Schannep’s Dow Theory than for the classical. From this
finding, we derive three conclusions:
a)
The myth of Schannep’s Dow Theory
being too restive is just that: myth. When there
is tailwind (secular bull market), Schannep’s Dow Theory excels at sticking
with the prevailing trend, and accordingly, its trades manage to outlast those
taken in pursuance of the “classical” Dow Theory.
b)
Schannep’s Dow Theory is better in
sync with cyclical bull markets. Longer trade duration implies that more “meat”
from each cyclical bull market is extracted by Schannep’s Dow Theory.
c)
Longer trade duration also tells us
that Schannep’s Dow Theory is better at timing the entry and exit points,
as it stays more time invested in the market.
Average gain in each
transaction
Schannep: 53.37%
Traditional: 51.27%
Comment:
Once again,
Schannep’s Dow Theory beats the classical one on this score. However, to be
fully sure of the superiority of Schannep’s Dow Theory, it is necessary that we
annualize performance so that we account for Schannep’s longer average
trade duration. If we normalize, we obtain the following figures:
Schannep: 22.55%
Traditional: 21.85%
Comment:
Please mind
that this figure merely divides the average gain in each transaction by the average
time in each transaction. We can see given an equal amount of time (i.e. 1
year) Schannep’s Dow Theory manages to extract more profit from the market than
the DowTheory.
While ca. 0.7%
annual outperformance doesn’t seem much, we have to bear in mind that, once we
capitalize, we see that Schannep’s competitive edge builds up significant
profits over time:
If we take
base=100 in 1954 for both Dow Theory “flavors”, such 100 would have grown into:
Growth of 100 USD since 1954
Schannep:5594
Traditional: 3301
Please bear
in mind that this capitalization merely refers to the 10 transactions for the
classical Dow Theory and 11 for Schannep’s one, taken during secular bull
markets. Thus, this is not the total performance of either Schannep’s or the “classic”
Dow Theory (as the gains made during secular bear markets are not included). It
is merely an indication of what to expect during secular bull markets. However,
the figures above clearly show that Schannep’s does a much better job at
cumulating profits when conditions are favorable.
Total time in the market
(total days invested during secular bull markets)
Schannep:9502 days
Traditional: 8563 days
Comment:
This
statistic shows that Schannep’s Dow Theory manages to “stick” to the cyclical
bullish trend longer than the traditional Dow Theory. Since, as we have seen,
profits are larger for Schannep’s Dow Theory we conclude that Schannep’s Dow
Theory is more efficient at selecting the right trends. More time on the market
also suggests that Schannep’s Dow Theory tends to get’s us early aboard
(and earlier than the “classical”
one). Furthermore, since I know that Schannep’s Dow Theory tends to exit a
trade earlier than the classical Dow Theory, we have to conclude that the time
spent on the market is well spent.
This
assertion is proved if we divide the total percentage points gained by the
total time spent in the market.
Total percentage
points gained (non capitalized summation):
Schannep:587.07
Traditional: 512.74
Total time in the market:
Schannep:9502 days
Traditional: 8563 days
Schannep:0.0617%
Traditional: 0.0598%
Thus, we can see that given an equal amount of
time, Schannep’s Dow Theory was ca. 3.17% more efficient than the “classical
Dow Theory." This leads me to conclude that Schannep’s Dow Theory is a
better market timing device than the classical Dow Theory.
Winning transactions (trades) versus losing
trades
Schannep: 11 winners/0 losers (100% winners)
Traditional: 9 winners/1 losers (90% winners)
Comment:
While “past
performance is no guarantee for future performance," it seems that under
secular bull market conditions, Schannep’s Dow Theory is better tuned with the “pulse”
of the market.
Since we are analyzing
transactions under secular bull markets, the only loser incurred by the “classical”
Dow Theory is of minor importance (-5.60% in 1990). However, it is noteworthy
that the equivalent trade taken in pursuance of Schannep’s rules, resulted in a
modest gain of +2.25% proving, once again, that under challenging market
conditions, Schannep’s flavor does a much better job at protecting one’s
equity. It is not the same to lose -5,60% than to win +2.25%.
Profit factor
Profit factor
is the quotient of total points gained divided by total points lost. More about
the importance of a healthy profit factor here.
From 1954 to
2013, we get the following profit factors:
Schannep: Infinite (no hype)
Classical: 92.55
Of course, we should take such astronomic profit factors with a grain of salt. For sure the future, is going to produce some losing trades (even within secular bull markets), which will lower our actual profit factors. However, one thing is clear, both Dow Theory flavors do a great job at letting profits run and cutting losses short, as expressed by high profit factors.
.......
Well, we this
comparative study of both Dow Theory flavors under secular bull markets is
drawing to an end.
Schannep’s
Dow Theory outperformance is kind of an accomplishment, since during secular
bull markets it is very difficult to beat buy and hold or anything closely
resembling it (as the “classical” Dow Theory, which theoretically is less prone
to trading and hence is more similar to buy and hold). This is a testament to
the net superiority of Schannep’s Dow Theory.
Even though,
Schannep’s outperformance under secular bull markets, is certainly good news, I
must confess that I am more interested in comparing both Dow Theory flavors
when the going gets tough, namely, under secular bear markets. Rule number one
of investing is not to lose money; and money is lost, and in spades, during
secular bear markets. Thus, instead of getting greedy and rejoice at Schannep’s
outperformance during secular bull markets (when even buy and holders can make
a nice buck without the threat of a killing drawdown), I am more interested in
seeing how both Dow Theory flavors fare under adverse market conditions (i.e.
secular bear market). It is under market stress when I expect to see Schannep’s
Dow Theory to really shine; being the outperformance under secular bull markets
just an appetizer.
Thus, readers
of this blog stay tuned for the next issue of this “Face-off” saga.
To be continued
Sincerely,
The Dow
Theorist
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