Wednesday, February 4, 2015

Dow Theory Special Issue for February 4: It is not a primary bear market…

…In spite of what other Dow Theorists may say

Last Friday, January 30, the Transports violated their secondary reaction lows, and, hence confirmed the Industrials which had done so January 28. As reported by Mark Hulbert  of “”, the Dow Theory is now “flashing” a “sell” signal. In his opinion (apparently backed by other Dow Theorists) the confirmed violation of the January 15 closing lows constituted a primary bear market signal under the Dow Theory.

You can find Mark Hulbert’s article here.

What’s my take on this?

Hulbert himself is keenly aware that Schannep’s Dow Theory requires the S&P 500 to “join the parade” so that a primary bear (or bull) market signal is flashed.  Since the S&P 500 has hitherto refused to confirm no primary bear market has been signaled according to Schannep’s Dow Theory

The Transports and Industrials may signal a primary bear market on their own, provided that under “Rhea/classical” Dow Theory a secondary reaction lasting at least three weeks exists, and thereafter the +3% rally on at least one index followed. This was not the case on January 30.

Therefore, in order for the Industrials and Transports to flash a primary bear (bull) market signal with the S&P500 not confirming, the whole set up had to correspond with that of the classical/Rhea Dow Theory (the "original" one, as Schannep puts it on page 99 of his book). In other words, the secondary reaction leading to the bear (bull) market signal has to be appraised according to the Rhea/Classical Dow theory. And while Schannep has unearthed quotes of Hamilton and even Rhea where they refer to a shorter time frame (less than three weeks), Schannep during his book makes clear that most “classical” Dow Theorists stick to the three-week minimum timeframe (which is true, as Richard Russell, of the "" would never declare a secondary reaction with less than three weeks time; and I have read most of Russell’s newsletters since the late ninety fifties).

Thus, we cannot mix apples with pears. If we appraise secondary reactions as per Schannep’s rules, then the S&P 500 must be present for a signal to be given. Under Schannep’s Dow Theory the S&P 500 is the preeminent index, and must be always present for a signal to be flashed. Thus, Schannep requires the following combination for a signal to be given:

S&P 500 + (Industrials and/or Transports)

This does not mean that the “original” “classical/Rhea” Dow Theory is to be discarded. If a signal is given by the “original” Dow Theory, this signal is to be taken. In most instances (according to Schannep’s book 42 out of 44) Schannep’s Dow Theory is more reactive and flashes a signal in advance of the “original” one.

Furthermore, here I have reported that Schannep’s Dow Theory tends to be more responsive than the “Rhea/classical” one.

The bottom line is clear: if we want to play by the “original” “Rhea/classical” Dow Theory, then we have to stick to it to the fullest extent (three weeks declining prices and demanding a retracement of the preceding primary bull market swing of 1/3 or more). What we cannot do is to appraise secondaries with Schannep’s rules and, at the same time, be “classical” by ignoring the S&P 500.

All the foregoing are not mere musings. They have been confirmed very recently by Jack Schannep to this blogger truly yours.  So, if you want to apply Schannep’s Dow Theory, you better take into account the S&P 500.

One thing is clear: Taking decisions on "real time" is much harder than when looking at a chart ex post facto. I myself had my qualms.

Why the S&P 500 must always be present under Schannep’s Dow Theory?

First reason: Schannep’s book defines “bull” and “bear” markets as a +19% advance or -16% on both the Dow Jones (I guess “Industrials”) and the SP500. So when looking for “confirmation” in order to reach the +19/-16% threshold, Schannep clearly includes the SP500. It must be “in” to confirm.

Second reason: Furthermore, since Schannep’s Dow Theory declares the existence of secondary reactions much earlier than the traditional one, I find it makes sense to “tame” the enhanced responsiveness by demanding that the SP500 must always be present. In other words, if we just demand the INDU and the TRAN and at the same time we declare secondary reactions that don’t exist under traditional Dow Theory, we risk flashing too many bear market signals (as would have happened last Friday, January 30). This is especially true when we are dealing with shallow secondary reactions (i.e. barely more than 5%) which makes it even more probable to violate the lows due to mere noise.  Schannep made clear in his book that the SP500 is the paramount index nowadays, and hence it should not be easily disposed with.

Third reason: the SP500 with 500 stocks (even though unevenly weighted) is less likely to “overreact” than the Industrials or Transports which contain fewer stocks. In other words, I feel the SP500 is more representative of the broad market and less prone to whipsaws.

Fourth reason:  Page 77 of Rhea’s book still reverberates in my mind: The lows of the last completed secondary reaction are (at least “usually”) a valid primary bear market signal. We should never overlook such lows, which pertain to the “classical Dow Theory” and “generally” are a valid alternative primary bear/bull market signal. Furthermore, I am reading a classic “Profits in the stock market” by Gartley, and while I feel in saver hands by just following the Dow Theory and forgetting cycles, etc., he makes clear that the last secondary reaction lows, with or without Dow Theory tend to signal a change of trend. Thus, in many market junctures (such as ours right now) the lows of the last completed secondary reaction (in this case, the one of December 2015) are not to be forgotten. All in all: we don’t have the abyss below if we demand the SP500 to be present for the current primary bear market signal to be given (under Schannep’s DT). While I don’t have the final answer (and maybe it does not exist, as there is room for interpretation), it could well be that the violation of the last completed secondary reaction lows (even without the SP500, just by the INDU and TRANS) could also signal (under traditional Dow Theory) a change of trend (Rhea, page 77), or, at least, could be a warning to sell down a little bit. I plan to write a little bit about this in the blog (if time allows), as I feel it is important.

So, we will continue to observe the market. If the S&P 500 violated the last recorded secondary reaction lows (horizontal read line on the right of the chart), then will be a primary bear market signal be given. In the meantime, we wait.

No primary bear maket yet...or never. Stay the course.

The Dow Theorist

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