Thursday, October 8, 2015

Dow Theory Update for October 8: Primary bull market signaled for US Stocks on Oct. 7

At least theoretically, as it has been a very dubious signal.

The S&P 500 closing high of September 16th, 2015 was 1995.31. Yesterday, October 7th, the S&P 500 closed above such a closing high by closing at 1995.83. Thus, the S&P 500 managed by a hair to exceed the closing highs of the secondary reaction, and by doing so confirmed the higher closing high already made by the Industrials on October 5th, 2015.

According to Schannep’s  Dow Theory for a primary bull market signal to occur, we just need the SPY and other index to break above the secondary reaction closing highs. Thus, even though, the Transports remain below its secondary reaction closing highs, a primary bull market has been signaled.

However, in the spirit of full disclosure, I must say that I have not acted on this signal. In other words, my short term trading remains with a “bear market filter," and the long term one remains flat, out of the market. I recognized yesterday’s signal as a valid Dow Theory primary bull market signal, but I also know that I have to exert judgment. After all, Schannep, as Rhea did in the past, in some instances knows when to “break” the rules. Thus, in January 2000 when both the Industrials and the S&P 500 made higher closing highs but the Transports refused to confirm, Schannep ignored the breakout (“Dow Theory for the 21st Century" pages 116 and 119 –note 4-). There are other such instances when Schannep exerted judgment.

So why in my private trading I am acting as if no breakout occurred?  There are many reasons which I will summarily list.

1) The SPY ETF, which is tries to reflect the S&P 500, and which I normally use for my Dow Theory readings, did not exceed the September 16th closing highs. While occasionally there may be small divergences between the two, yesterday there was a glaring divergence. On September 16th, the SPY closed at 200.18. On October 7th, the SPY closed at 199.41, that is 77 cents below the closing highs. Since the SPY is roughly ten times smaller than the S&P 500, 77 cents in the SPY is tantamount to 777 cents in the S&P 500, which equals 7.77 points for the S&P 500. Thus, we can perform the following math:

Closing high of Oct 7th: 1995.83


7.77 points (which would the S&P 500 equivalent of the difference between the SPY Sept 16th and Oct 7 closing highs)

Equals = 1988.06, which is clearly below the closing highs made by the S&P 500 on September 16th.

My gut feeling says that since many people had their eyes fixated on the September 16th closing highs, waiting to buy the breakout, there was an effort to levitate the S&P 500 price in the futures markets above the critical level. This is why:

a) it was a breakout by a hair.

b) It did not remain a long time above the critical level.

c) The SPY failed to follow suit (as arbitrage has some lagging). Here you have the chart (screenshot taken at 12:49 pm). The read horizontal line displays the critical level to be broken out. 

The SPY remains below its September 16th closing highs.

The mini S&P 500 (December contract) immediately after reaching the “higher” closing high, took a nose dive in after-hours trading, which seemed to confirm to me that the higher closing highs were somewhat frail.

Please mind that people look at the S&P 500 but in reality, they buy the SPY.

Having said all this, one thing is clear: Had the SPY exceeded its September 16 closing highs even by a mere cent, I would have acted on the signal.

2) Schannep’s technical big picture is bearish. In his last letter to subscribers he warned about a bearish crossover on the long term stochastic, a top in long term RSI, etc.

3) The stock market is short term overbought. I know that overbought conditions may persist longer than one expects, but, a pullback may develop from the current level any moment now.

4) The Transports are clearly below the September 16th closing highs. I know I don’t need three indices to confirm under Schannep’s Dow Theory. However, being confronted with a highly dubious higher closing high by the S&P 500, lack of confirmation by a less manipulated index, advocates for caution.

5) While the Dow Theory is not concerned with intra-day highs, it is worth noting that the Sept 17 highs have not been bettered (yes, intra day highs were made one day latter not on September 16th).

6) The SPY and the S&P 500 remain below the 200 and 50 days moving average, and both moving averages are currently declining. I know that the Dow Theory is more reactive than moving averages and, under “normal” signals, we do well disregarding moving averages, as we have a superior timing device (more about the superiority of the Dow Theory versus moving averages here). However, when confronted with a highly weak, both in extent and time (yes, time, the time that the higher closing high has effectively remained at that higher level, which has been negligible), the moving averages seem to be telling us: “Wait a little bit. If it is a real primary bull market, the market will continue to go up, and maybe tomorrow or the day after tomorrow you get a better quality signal”.

 7) While not strict Dow Theory I always keep an eye on the S&P500 advancing issues. Since September 30, the SPY has been edging higher, while the Advancing Issues has been declining. Such a divergence seems to suggest that the rally is petering out.  Higher highs in the index are not equaled by more advancing issues. Here you have a chart:

Advancing issues diverge from the SPY

8) Another indicator I monitor, the difference between new 52 weeks highs minus 52 weeks lows, has been slightly edging lower in the last three days, while the SPY was making higher highs. This tells me that there is no broad participation in this rally.

9) Such a lack of strength seems to be confirmed by the fact that stocks trading below the 200 day exponential moving average have made huge advances in the last few days. Are we just seen a short covering rally?

10) My misgivings about the lack of internal strength, have been confirmed by the blog of Dorsey Wright “Systematic Relative Strength." In his latest weekly recap, they noted that the bottom relative strength decile (that is the worst momentum stocks) clearly outperformed both the index and the high relative strength stocks (top decile).

9) While volume is to be taken always with a grain of salt, volume has been bearish. It increased in declines and decreased when the SPY was rallying.

10) The benefit of doubt is to be given to the existing trend (“the trend is your friend”), which is bearish.

Please mind that I am not giving you fundamental reasons for not having honored the primary bull market signal. I am not mentioning that, according to many pundits, stocks are overpriced, that according to Zero Hedge, the world is ending, etc. No: I just use as a prop technical knowledge.

Please mind that if either the S&P 500 had clearly broken up (either in extent, or at least “time," that is being, let’s say, three hours above the critical level) or the SPY had broken up, even by one cent, I would have honored the signal, no questions asked, and no additional technical bullshit would have been given by this blogger truly yours.

However, this was not the case.

Furthermore, I am practical. If I had taken the primary bull market signal, my Dow Theory stop would be lying ca. at -6.48% below yesterday’s close. This is an indeed narrow Dow Theory stop. While, this is good, since  our risk of loss is well contained, it increases the risk of a whipsaw. Hence, I say to myself: “Wait until tomorrow, or the day after tomorrow, for either the SPY to break up, or at least the S&P 500 to make a clear breakout. If I get somewhat late, I will maybe forgo 0.5% of performance (as I risk the SPY being higher than on the close of October 7th) but 0.5% is the price I willingly pay for: (1) a more confirmed trend, (2) a somewhat more ample stop, hence, less risk of whipsaw. If it is a real signal, sooner or later, I will see it on the chart. Furthermore,  I will see it at quite favorable price when compared with my Dow Theory stop. So wait.”

Furthermore, and this is very personal, my long term trading along with the primary trend does not involve buying the SPY, or any other similar ETF (i.e. equally weighted S&P 500). When I get a “green light” (primary bull market) I am interested in high momentum stocks, and as I have written above, such stocks are currently laggards. In other words, the stuff I am interested in, is in relative terms “cheap." I don’t need to rush, because high momentum stocks are not currently going to the moon. If today by the close or tomorrow I get a “buy” signal, I need not worry.

The Dow Theorist

No comments:

Post a Comment