Dow Theory special issue: Dow Theory Review for 2013.

Putting 2013 in perspective

Let’s briefly recap how our Dow Theory analysis fared in 2013. Did we do a good job at determining the primary trend of the markets? This post should be an eye-opener for many skeptics.

US Stocks

The year began on January 2 with a primary bull market signal, as you can read here and here.

 

This primary bull market signal lasted until June 21, when a primary bear market was signaled, as explained here and here. The long position was closed with significant profits percentagewise (and taking into account the time involved).

The primary bear market was short-lived and on July 18, a new primary bull market was signaled, as explained here, and more in-depth here. This primary bull market remains in force as of this writing, as significant unrealized profits have been built up.

Here you have a chart displaying 2013, from January 2nd (first trading day) to today December 31st. The orange rectangle displays the period we were sitting on the sidelines due to the primary bear market signal.

2013: SPY's action

Now let's have a look at profits, as shown in the spreadsheet:

  

	BUY AND HOLD			DOW THEORY
	SPY			SPY
Jan 2	146.06		Jan 2	146.06	entry
Dec 31	184.69		June 21 Primary bear mkt	159.07	exit
Proft	0.264480351		Profit 1 (realized)	0.089072984
			July 18 Primar bull mkt	168.87	entry
			Dec 31	184.69	end of 2013
			Profit 2 (unrealized)	0.09368153
			Nominal profit (1+2)	0.182754514
			Capitalised profit	0.191099007
Dow Theory outpeformance		-0.07338134

Please mind that the real profits made by the investors are those that I label "capitalised". This is the money you'd have made starting with 100 units, cashing out 108.907 units at the June 21 exit and reinvesting the 108.907 units at the second buy signal on July 18. As you can see the Dow Theory made a remarkable 19.11%. Nonetheless, in this bumper year, buy and hold managed to make 26.44%. For those thinking that buy and hold was a better than trying to time the market, please heed this: Don't get blinded with 2013, since this year was the best year for the S&P since 1997. Furthermore, as I explained in my post "How often does the Dow Theory outperform Buy and Hold", we have to bear in mind that 41.2% of any given year the Dow Theory underperforms buy and hold. The global outperformance of the Dow Theory (be it "classical" or Schannep's) is made in relatively few years (normally, when markets are weak).

You can see what I have stated many times: it is close to impossible to beat buy and hold when there is a strong trend, since by definition timing devices (such as the Dow Theory) will always get aboard too late or exit prematurely (when there is a failed signal). However, as I have said ad nauseam in past posts, the Dow Theory manages to outperform buy and hold (both in terms of performance and in terms of reduced volatility) thanks to the “bad” times. In other words, the outperformance comes from cutting losses short. Thanks to the Dow Theory we manage to win slightly less than buy and hold when the sun shines, but we lose much, much less during bad times. The overall result is slight outperformance and, more importantly, dramatically reduced drawdowns. You are referred to the “Face off” saga for more information.

Conclusion: the Dow Theory did a good job keeping us most of the year on the right side of the market. While many fundamentalists and macro analysts were predicting a stock market decline, the Dow Theory, impervious to ego or fundamentally-based ideas, told us that the trend was up. Out of 12 months, the Dow Theory had us invested in the market 11 months and some days. I pay with pleasure the price of being some weeks out of the market (and foregoing the corresponding performance) as an insurance against a real primary bear market.

Gold and Silver miners

On January 24, a primary bear market was signaled for SIL and GDX, the gold and silver miners ETFs, as was as explained here.

The primary bear market signal was a real, very real one and both ETFs staged a monstrous decline (with a maximum drawdown exceeding 50%). Thus, once again, the Dow Theory identified early enough a change in the primary trend, and spared investors from devastating losses.

The primary bear market signal was reversed on August 14, when a primary bull market signal was signaled, as explained here and here. Since not all signals can be successful (if they were, everybody would follow the Dow Theory thereby rendering it ineffective), this was the failed signal of 2013, since on November 20 a primary bear market was signaled (explained here and here), which resulted in closing long positions at a loss for SIL and GDX.

It is worth mentioning that in real time I showed my lack of comfort with the new primary bull market signal, since the actual metals, gold and silver, were still (and remain today so) in a primary bear market. I quote from my August 14^th post:

Of course, if gold and silver were in a primary bull market of their own, I’d feel even more comfortable with the current primary bull market signal for GDX and SIL. However, until now, and while looking less bearish, it is too early under the Dow Theory to declare the existence of a primary bull market for gold and silver. The longer gold and silver remain under the grip of a primary bear market, the more headwind for SIL and GDX.

Here, I also expressed in real time that the initial stops resulting from the primary bull market signal and the risk reward ratio was not ideal, and, accordingly, I was of the opinion that one should trade very small:

  

Thus, this particular primary bull market signal and its concomitant setup (primary bear market lows, secondary reaction, pullback, breakup) is not the best one in terms of reward risk ratio. We don’t know how much we stand to make, but we know how much we stand to lose if the market suddenly reverses without any intervening secondary reaction. Such initial ample stops of -45% for SIL and -29.16 for GDX warrant caution, which means that I would never make a commitment that could entail such a big loss. Personally, I’d never allow a loss greater than 10% of my total trading/investing equity. While this is very personal, this necessarily implies a commitment of modest proportions for GDX, and an even smaller one for SIL

We learn more when losing than when winning. The failed signal for SIL and GDX, is a very good example. In the quotes above you can see that I was less than enthusiastic about the primary bull market signal. I saw headwind (the inability of gold and silver to have a primary bull market of their own) and to add insult to injury, we had a poor risk reward ratio. 

Here you have a chart displaying 2013 (GDX), from January 2nd (first trading day) to today December 31st. The orange rectangle displays the period we were sitting on the sidelines due to the primary bear market signals.

2013: GDX (gold miners) action

Now let's have a look at profits (or rather, losses), as shown in the spreadsheet:

 

	BUY AND HOLD			DOW THEORY
	GDX			GDX
Jan 2	47.1		Jan 2	47.1	Entry
Dec 31	21.13		Jan 24 primary bear mkt	43.23	Exit
loss	-0.551380042		loss	-0.082165605
			Aug 14 primary bull mkt	28.7	Entry
			Nov 20 Primary bear met	22.85	end 2013
			loss	-0.203832753
			Nominal loss	-0.285998358
			Capitalised loss	-0.269250316

Dow Theory outpeformance

0.28212973

So, we can see that GDX lost an astounding -55.13%. The Dow Theory managed to contain losses to just -26.92% (assuming a foolish investor that would have been 100% invested in GDX, something I did not advice to do). Even when facing adversity (and a bear market that erases in one year -55.13% of value, is real “adversity”), the Dow Theory outperformed buy and hold by 28.21%.

As to SIL, here you have a chart displaying 2013, from January 2nd (first trading day) to today December 31st. The orange rectangle displays the period we were sitting on the sidelines due to  primary bear market signals.

2013: SIL (silver miners) action

Now let's have a look at profits (or rather, losses), as shown in the spreadsheet:

	BUY AND HOLD			DOW THEORY
	SIL			SIL
Jan 2	23.46		Jan 2	23.46	Entry
Dec 31	11.2		Jan 24 primary bear mkt	21.11	Exit
loss	-0.522591645		loss	-0.100170503
			Aug 14 primary bull mkt	15.36	Entry price
			Nov 20 Primary bear mkt	11.6	end 2013
			loss	-0.244791667
			Nominal loss	-0.34496217
			Capitalised loss	-0.320441265
Dow Theory outpeformance		0.20215038

So, we can see that SIL lost a daunting -52.25%. The Dow Theory managed to contain losses to just -32% (assuming a foolish investor that would have been 100% invested in SIL, something I did not advice to do). Even when facing adversity (and a bear market that erases in one year -52.25% of value, is real “adversity”), the Dow Theory outperformed buy and hold by 20.21%.

So the overall balance from a Dow Theory perspective for GDX and SIL is good: there was a successful primary bear market signal (which saved investors many percentage points) and a failed primary bull market signal which lost investors a lower amount of percentage points. In other words, in spite of the failed signal, the Dow Theory outperformed buy and hold (in the sense that it lost “less” than a buy and hold position during 2013.

Gold and Silver

2013 began with an ongoing primary bear market in gold and silver which has been signaled by this blogger truly yours on December 20^th, 2012 (as explained here)

2013 is over and precious metals have suffered heavy losses in 2013, and the primary bear market signal remains fully in force. Thus, we can talk of a successful primary bear market signal, in the sense that investors have been spared heavy losses. I insist; the beauty of the Dow Theory lies not so much in “outperforming” nicely ascending markets (as stocks in 2013) but rather in determining the onset of a primary bear market soon enough so that losses are avoided. 

Here you have a chart displaying 2013 (GLD), from January 2nd (first trading day) to December 31st.

2013: GLD's (gold) action

Now let's have a look at losses, as shown in the spreadsheet:

	BUY AND HOLD			DOW THEORY
	GLD			GLD
Jan 2	163.17		Jan 2
dec 31	116.12		dec 31	out of the market
loss	-0.288349574		loss	No loss

Dow Theory outpeformance

0.28834957

Well, since according to the Dow Theory we were on the sidelines during the whole year, no losses were incurred by those investors who decided to follow the trend versus -28.83% lost by buy and hold. So the outperformance (as loss avoided) for the Dow Theory is clear.

As to SLV, Here you have a chart displaying 2013, from January 2nd (first trading day) to December 31st. 

2013: SLV (silver) action

Now let's have a look at profits, as shown in the spreadsheet:

	BUY AND HOLD			DOW THEORY
	SLV			SLV
Jan 2	29.92		Jan 2
dec 31	18.71		dec 31	out of the market
loss	-0.374665775		loss	No loss

Dow Theory outpeformance

0.37466578

Since according to the Dow Theory we were on the sidelines during the whole year, no losses were incurred by those investors who decided to follow the trend versus -37.46% lost by buy and hold. So the outperformance (as loss avoided) for the Dow Theory is clear.

Final remarks:

It has been rightly said that US Stocks was the only place to be in 2013. Of course, this is being said by market analysts, once the year is almost over and with the benefit of hindsight (ex post facto).  We said the very same thing in real time on this Dow Theory blog: Primary bull market for stocks; mostly primary bear markets for precious metals and their miners.

However, in real time, very few names come to my mind that said that US stocks were, almost, the only place to be for 2013. Of course, the “fundamentalist” or macro camp got it wrong (at least this year). One of the few "fundamentalists" that got it right (as far as gold is concerned) was blogger FOFOA who  based on very sound analysis made an educated guess as to gold falling hard during 2013. Here you can read his article. 

Nevertheless, even on the technical camp, few names did a good job (do you remember the Hinderburg omen, that repeatedly and wrongly predicted a market top?). I am sorry to say that Russell, whose “Dow Theory Letters," contain less and less Dow Theory, was indecisive all year long and changed his stance on repeated occasions (example here and here), thus not giving any actionable advice to his followers. On the other hand, Jon Strebler, Russell’s associate, took the right side of the stock market during 2013, by merely acknowledging that the trend is your friend. By the way, Strebler by doing away with wishful thinking also took the right side of the market as far as gold is concerned.

 
Schannep, of "thedowtheory.com", of course, is one of these few names that identified the right trend by sticking to the Dow Theory. David Moenning, of the State of the Markets, whose analysis, has been praised before on this Dow Theory blog, was also on the right side of the market during 2013.

 

The performance I showed for 2013 should be taken with a grain of salt. The numbers I showed merely serve to stress the profits made in long positions in stocks and losses avoided in precious metals, since 1 year is too short a period to evaluate performance. To do this, I’d need at least 2 ½ or 3 years of performance (and it would be still somewhat premature). Thus, the goal of this post was merely to show how during 2013 the Dow Theory managed to rightly track the prevailing trend of several markets, and outperform buy and hold (by avoiding being invested in the precious metals arena). We should not get obsessed with short-term profits (and one year is short term when it comes to profits when investing along the primary trend), as they take care of themselves once the investor is able, on average, to be on the right side of the market (thereby catching a significant amount of trends and, by the same token, cutting losses short when (a) either the trend changes after a nice run up or (b) it is a failed signal).

Have a happy new year 2014

Sincerely,

The Dow Theorist