Trends unchanged for gold, silver and their miners: that is bearish
On November 21st,
2016 a primary bull market was signaled, as was reported here
Let’s further
delve into the signal. First of all, let’s take a look at the charts
 |
| The highs of the last primary bull market (red horizontal lines) were bettered by the three indices: New primary bull market |
After the
primary bear market signal of November 2rd, 2016 (signal which has
not heeded by Jack and Bart Schannep, as explained here), US stock indices
rallied with no respite until the last recorded primary bull market closing highs (red horizontal lines and blue arrows) were jointly bettered by
the Industrials, Transports and S&P 500. The Transports (middle graph) were
the first to better their last recorded primary bull market highs (11/7). The
Industrials did so on November 10th, and eventually the S&P 500
confirmed on November 21rd, thus being signaled a primary bull market signal.
Please mind that as per Rhea’s and Schannep’s Dow Theory the breaking out of
the last primary bull market closing highs constitutes a legitimate primary
bull market signal. While this is not the most usual primary bull market signal
(the “usual” one entails the development of a secondary reaction against the
primary bear market, subsequent pullback and breaking out of the secondary
reaction highs), it is a fully valid one.
All in all since
November 21st, 2016 the primary trend is bullish. Furthermore, as
per the classical Dow Theory (and according to each possible interpretations
thereof), the primary trend is bullish as well.
As to the Dow
Theory when applied to weekly bars, while I still didn’t have the time to write
an in-depth post, the trend has turned bullish, which is supposed to be
tailwind for the current primary bull market signal (as determined by the daily
bars). In other words, the trend in the higher time frame (weekly bars) is
supportive and in gear with the trend in the lower time frame (daily bars).
So overall,
technically at least, the trend is very bullish. I see, though, two clouds on the horizon (which
nonetheless, I disregard, as I am strictly a technical trader). Please mind
that “clear skies” in real time trading are a very rare occurrence. This is why
it is so difficult to be a rule-based trader. One thing is back testing, another
quite different thing is to trade in real time and stick to the rules no matter
how many “clouds” we see on the horizon:
The first issue
that bothers me is the “narrow ranging” which has been plaguing the stock
market since 2010. The second issue is the age of the current cyclical bull
market. I will further elaborate on both “clouds”.
Since 2010 the
market has been experiencing some sort of “fibrillation”. In other words,
further declines following primary bear market signals are short lived and
shallow, whereas further advances following primary bull market signals lack
enough magnitude before being reversed by the next primary bear market signal.
I have already written about this unpleasant market environment here.
I have tabulated
all trades taken as per Schannep’s Dow Theory since 1953. I calculated, among
other items, the total amplitude of an upswing (that is from primary bear
market low to primary bull market top), and the amount of the further advance
until the top following a primary bull market signal. These are two key figures. The only way for any Dow
Theory flavor to thrive is to have swings (from bottom to top) of sufficient
magnitude so that if we deduct the percentage lost when entering (distance
between entry price and bear market bottom) and exiting (distance between
market top and exit price) we still have a healthy remainder: this remainder is
the “meat” or our takeaway home from each Dow Theory swing. We know that we
shed ca. 7-8% when entering and exiting. Thus, we can say that roughly we stand
to lose ca. 15% of each upswing. If the upswing has a magnitude of let’s say
40% we will stand to make ca. 25% on the trade. If the upswing has a magnitude
of just 15%, we will likely break even. A narrower range will entail outright
losses. Please mind that this is not carved on stone. These are just rough
calculations which, though, are well grounded in the historical record.
We do not only
need a sufficiently ample upswing. We also need that the further advance
following the primary bull market signal has enough “oomph” and is not aborted
soon after the primary bull market signal.
From 1953 until 2009, the average
upswing (from bear market low to bull market low) amounted to 54.15% (median 39.59%). Impressive, isn’t it?. Let’s
take a 40% figure (close to the median). If we subtract 15% (ca. 7-8% lost when
entering and exiting) we have a likely gain of ca. 25% per trade. By the way,
this boe estimate quite accurately reflects the historical Dow Theory record:
25% made in ca. 1 ½ years (roughly estimate of the average trade duration)
translates into a ca. 16% p.a. performance which is not far from the historical
Schannep’s Dow Theory record until 2009.
Well, now fasten
your seat belts: From 2010 to date, the
average upswing amounted to just 25.88% (median 23.33%). In other words, the
average upswing has been ca. cut in half.
In my opinion this is clearly “fibrillation” and headwind for the Dow
Theory. Noise has dramatically increased (“noise” being the lesser amplitude of
upswings versus the amount of signals).
And what about
the subsequent advance following a primary bull market signal. In other words, after buying following a primary bull
market signal, is it very likely that the market will immediately reverse and
hence we will make a loss or realize meager gains?
From 1953 to 2009 the further advance following a
primary bull market signal was 37.98% (median 27.03%). In other words, if we subtract ca. 7-8% (the exit
tends to be ca. 7-8% below the primary bull market top), we stand to make ca.
20% (more if we take the average instead of the median) on each trade.
However, from
2010 to date, the further advance following a primary bull market signal has
been maimed. The further advance following a primary bull market signal was a
meager 12.16% (median 7.6%), hence leaving very little “meat” available to
profit from. If we deduct ca. 7-8% from the top, we are just close to break
even. No loss, but, of course, very little gain.
Note: All calculations have been made following the
S&P 500; calculations are similar but not identical using the Industrials
or the Transports.
If we couple
lack of follow through following a primary bull market signal with an equally
maimed further decline following primary bear market signals (which is the main
driver of outperformance versus buy and hold, the larger the decline following
the primary bear market signal, the better for the Dow Theory, as I will prove
with numbers in a future post), we have a quite dismal picture. When getting
out (primary bear market signal), the decline stops and we are forced to re-buy
(next primary bull market signal) at normally higher prices, and when getting
in (buying) the market is close to making a top and hence we can hardly build up
profits.
Let’s be clear about one thing: If I were to believe that from now on future
primary bear market signals would be met with scant follow through, then I ‘d
be better deserting the Dow Theory for good (at least Schannep’s which in
the only “flavor” with reliable statistics and hard and fast rules, as the
“classical” sadly is plagued with many subjective interpretations). In other
words, if further declines following a primary bear market signal as
determined by Schannep's Dow Theory were an oddity of the past
(“oddity” which has persisted since 1960 even in recent times, albeit to a more
mitigated extent), we should declare
Schannep’s Dow Theory as dead, as the main source of outperformance versus buy and hold (further declines
following the primary bear market signal) would be cut short.
The
very same remarks I made concerning the lack of follow through after a primary
bear market signal are fully applicable to the lack of further advance
following a primary bull market signal. Further declines after the bear
market signal are our main source of outperformance whereas further advances
after the bull market signal are our main source of raw performance. Absent the
two the Dow Theory will underperform and
have meager returns. Please re-read the previous sentence. If we just had lack
of further decline following primary bear market signals but further advances
following primary bull market signals were sound, we would be underperforming
but, at the same time, we would be having solid performance (i.e. buy and hold
20% p.a. and the Dow Theory 15% p.a.) which is a quite comfortable situation,
given that sooner or later the Dow Theory will save us from a crash (or big
decline).
On
the other hand big declines following a primary bear market signal coupled with
scant follow through following a primary bull market signal would imply Dow
Theory outperformance versus buy and hold, but, at the same time, a likely
negative performance (i.e. buy and hold, -20% versus Dow Theory -5%).
Thus,
while it is unpleasant to underperform, it should give us solace to have, as we
have, a keen and deep understanding of the nature of the underperformance.
My
personal take is that Schannep’s Dow Theory (and the Rhea/classical as well but
with more likelihood of higher drawdowns) is very solid. Why am I so sure? As an appetizer, please read here and here. I am convinced that
Schannep’s Dow Theory (and of course the “Rhea/classical”) is not dead. The
current ranging environment will sooner or later end. Rough patches plague all
trading systems (by the way all trend followers are suffering, not just the Dow
Theory) and we have to learn to live with them. The only way to live through
the rough patch is to deeply understand the trading system. And this is hard
work. No way around it.
The
second issue that bothers me is the
age of the current cyclical bull market. The current cyclical bull market (more
about cyclical bull markets here) is already very old. However, in real time it is very
difficult to predict its demise (as in real time there is almost a distinct 50%
probability of it continuing for some more months and percentage points). Furthermore, a last "gasp" of +20% is more than enough to close the current trade with profits, so one never knows. Hence, rather than relying on the statistical record of past cyclical bull markets, I
am more confident on the solidity of the Dow Theory to ride different market environments. All in all, the current cyclical bull
market got started in 2011, and hence it is an “old” one which implies that the
odds a cyclical bear market (more than -16% decline on both the S&P 500 and
Industrials as per Schannep’s definition)
are high.
Sincerely,
The
Dow Theorist
