Trends for gold and silver and their stocks unchanged
This is going to be a long post. Please bear with me,
and take your time to absorb it. Since writing this post has taken a good deal
of focus and energy, I’d likely take a pause in the coming days (unless trends
change).
Yesterday, a primary bull market signal was signaled for US stocks, as succinctly explained here.
Today, I am going to delve further into this signal.
On December 11, 2015, a primary bear market was
signaled, as appraised by Schannep’s Dow Theory.
The final closing lows of the primary bear market were
made on February 11, 2016 (Industrials and S&P 500), the Transports made
their lows earlier on January 20, 2016. From such lows a secondary reaction
against the primary bear market set in. The closing highs of the secondary
reaction were made on March 18, 2016 (Transports) and April 1st,
2016 (Industrials and S&P 500). From that point, the Transports declined
more than two days and more than 3%. The Industrials and S&P 500 did not manage
to decline more than 3%. More explanations about the setup here.
Furthermore, it suffices just one index to decline
more than 3% to setup stocks for the next primary bull market signal, as
explained here.
Even though the S&P 500 and the Industrials did
not decline by more than 3%, both indices declined for 4 days (minor closing lows
made on April 7th, 2016), and hence confirmed the Transports as far
the decline itself (not its extent) is concerned. The chart below displays such
a decline with orange rectangles. Here I’d
like to clarify one aspect. Schannep’s Dow Theory does not require the extent (more than 3%) confirmation when
stocks set up for a primary bull or bear market signal. However, the direction itself of the decline/advance and time thereof (i.e.
minimum of 2 days) should be confirmed. In other words, if the transports
had declined more than 3% but the INDU and SPY had simultaneously advanced
(hence refused to decline), there would not have been such a setup. Schannep
deals with this unusual situation (one index declines more than 3% and the
other two indices continue their ascent) in page 21 of his masterpiece (I do
mean it) “The Dow Theory for the 21st Century”. It is the so-called “B-5”
signal (page 21). Readers of this Dow Theory blog: If you are really intent on mastering
the Dow Theory, please read Schannep’s book at least five times. Digest it.
Absorb it. And you will do yourself a great favor.
After the closing lows of April 7th, stocks
broke out their respective secondary reaction closing highs and hence a primary
bull market signal was signaled.
Here you have an updated chart:
 |
| Details of the primary bull market signal. Red orange rectangles display the pullback |
I’d like to make some additional comments
concerning this signal.
The SPY rallied ca. 13.75% off the primary bear market
closing lows (SPY at 182.86). Hence we are talking of a powerful rally
(secondary reaction against the primary bear market). This also implies that we have a very awkward risk reward ratio, in
that our initial Dow Theory stop is likely to be at least -12.09% below an hypothetical
(and for some “real”) entry point at yesterdays close (SPY at 208.00) or
today’s open (SPY at 208.07). Here is the math:
Entry as per
"buy" signal
|
208
|
|
Initial Dow Theory stop
|
182.86
|
|
Likely initial loss
|
-12.09%
|
Readers of this blog know that, following a primary
bull market signal, the initial stop loss is to be set at the closing lows of
the previous primary bear market. More about the Dow Theory stop here.
I’d say that in 75% of the buy signals, the initial
stop loss (lows of the primary bear market) lies around 5-7% below the entry
price. In this specific case, the torrid rally which followed the primary bear
market low of February 11 (for the SPY) did not give a respite (that is a -3%
decline) until the SPY had advanced 13.75%. Hence, we are not under the best
initial risk/reward conditions. Should stocks begin to decline in earnest
without staging a minor rally of +3% in at least one index, we would be
confronted with a sizeable loss.
Of course, such an occurrence is unlikely, while the
past is no guarantee for the future, the “usual” primary bear market signal is
given some 5-7% below the top. In our case, even assuming that stocks started
to collapse today, and never better yesterday’s close, this would mean that
after having declined by 5-7% at least one index would oblige and rally by more
than 3%, and, thus, our exit would imply much contained (and usual,
average-like) losses.
However, we never know….
The torrid +13% rally, resulted in an entry price (SPY at 208.00) which is ca. 2.9% above our exit price of December 11, 2015. This is a rare occurence, as normally, and given the subsequent declines following a primary bear market signal, the next buy tends to be below the exit price. Here is the math: The average decline after the primary bear market signal to the final bottom amounts to ca. -12.97%. Since the "usual" entry price following a primary bull market signal is given at ca. 5-7% from the bear market bottom, we can derive that "normally" the entry price lies some good percentage points below the last exit price (primary bear market signal).
Now, I want to show my readers that I am not a computer,
and that I have feelings. However, I will also show that I override them and
stick to the rules.
I will confide: I feel very uncomfortable with this
primary bull market signal. Not so much for the bad risk/reward, which, as explained
above, is unlikely to result in a major loss, but for many other things, which
I will list.
Technical misgivings.
1) The
primary trend of the market, as appraised when using weekly bars, remains
bearish. Primary trends when appraised with weekly bars tend to closely
resemble “secular” trends (that is headwind in our case), albeit determined “technically”.
Bottom line: The very long term trend is and remains bearish. More about the “technical-secular”
trend here and the current bearish status here.
However, I live and die by “daily” bars (at least for me given my trading style), and hence, while very aware of the technical
"weekly" headwind, I honor the buy signal. Furthermore, big reversals of “secular”
bearish trends have always been foreshadowed by daily bars. So investors
should do their homework, understand the difference between “dailies” and “weeklies”
(hence read the two linked posts) and
decide by themselves.
2) The
cyclical bull market is aging. Schannep gives in his book the best definition
of cyclical bull and bear markets (pages 61-67 of his book). Any decline
exceeding -16% (confirmed by the S&p 500 and the INDU) will constitute a
cyclical bear market, and any rebound exceeding +19% off the lows of the
cyclical bear market will be defined as a cyclical bull market. In short, the
current primary bull market started in 2011. As per the profiling of cyclical
bull and bear markets made by Schannep (more on his website: https://thedowtheory.com/resources/bull-bear/historic-record/
), the current cyclical bull market is old. Hence, statistically the odds favor
a new cyclical bear market (which entails a median decline of -27.5%). However,
things are not so straightforward, as in any given year, the likelihood for the
cyclical bull market to survive an extra year is not so low (currently, it
could be a 50/50 probability), and,
thus, an old cyclical bull market is not sufficient reason for me to disregard
the current primary bull market signal.
As an important aside, please mind that cyclical bull
and bear markets are the proper “overlay” for Schannep’s Dow Theory primary
bull and bear market signals (roughly, very roughly, one cyclical bull may
contain two primary bull markets as determined by Schannep’s Dow Theory).
Hence, the bull and bear markets as determined by the Dow Theory (especially
Schannep’s) tend to be of shorter duration (but more effective, as far a
performance and drawdown reduction is concerned) than “cyclical” ones (which
are those more often referred to in the media). As an example, the average
duration of a cyclical bull market is 32.9 months, whereas the average duration
of a primary bull market as determined by Schannep’s Dow Theory amounts to ca.
(very rougly, as I don’t have updated numbers at hand, and lack the time to
update them) 479 days (more about it here), which is ca. 16 months.
3) The Rhea/Classical Dow Theory remains in a primary
bear market. Since the “classical” Dow Theory does not use the S&P 500, the
Transports have refused to confirm the Industrials, and hence the trend has not
changed. However, I’d like to note, that in most instances, Schannep’s Dow
Theory by getting in and out earlier than the “classical” tends to reduce
drawdowns and increase performance. So, as with “weeklies” the technical bearish
status as per the “classical” Dow Theory is not powerful enough for me to
disregard the signal given by Schannep’s Dow Theory.
Fundamental
missgivings
1) This is nothing new, but I see the economy in very
bad shape. Earnings are poor. However, countless bull markets have been missed
by those focusing on the shape of the economy. So this is not a reason to
ignore the primary bull market signal.
2) If we stick to valuation criteria, the US stock
market is not cheap. However, being a trend-follower at heart, I know that
expensive assets may remain expensive for a long time. Furthermore, one never
knows whether we are on the brink of a massive devaluation (or a new high tech discovery like free energy) which would propel
stocks higher. Nobody knows anything, me, of course, included.
However, there are also some encouraging aspects, namely:
1) Technically, Schannep’s
timing indicator (more about it, here), remains firmly in a bullish mode. This is technical tailwind.
2) Maybe there
is more demand for stocks than we suspect. Perhaps, there are deep reasons for
creating artificial demand for stocks in order to prevent a collateral collapse
(as Zero Hedge reported on April 12, 2016). I don’t care whether demand for
stocks is “natural” (little Joe buying) or “artificial” (Fed orchestrated).
Demand is demand. And I remember the adage “don’t fight the Fed”. If such an artificial
demand were to falter, the Dow Theory would let us know sufficiently close to
the top, so that we orderly exit.
3) One never
knows what the government has in store for us. What if, i.e., S&P 500
constituent stocks were to be considered as good collateral as US debt? What
if, at least, there were the firm commitment to support their price even if
this implied outright monetization. We really don’t know, but we could be close
to such an event. The Dow Theory “smells” change before we can fundamentally
explain it.
4) I precisely think (maybe it is a crazy economic
thought) that the worse things are economically, the greater the disparity
between the “have” and the “have nots”, the better for big business (to the
detriment of small business). Even under a shrinking economy there may be the
winners, like big businesses which coincidently, are listed on the stock market.
So the state of the global economy does not necessarily reflect the state of
the particular big companies which are constituents of the S&P 500.
Furthermore, since by its nature such indices drop the laggards, and include
the “winners”, it is very likely that amidst a stagnating economy the stocks
making the index will continue performing well.
5) In a disparity economy, it could be that stocks get
to be owned by the bedeviled 1% (which is actually, 0.1%) and hence owned by strong
hands not prone to sell. Hence, a declining economy with a tiny minority of
overlords might result paradoxically in strong hands, which brings to my mind
the following example:
During most of history, when massive poverty for the
99.99% was the rule, was the value of gold (the preferred vehicle for saving) low?
No, of course, because, the rich, albeit few, were really rich, and hence they
were “strong hands”. The overall
level of prosperity is not necessarily the best indicator for the value of an
asset. Its value (call it “price” if you want) will merely depend on
the selling and buying pressure. I can well imagine (and fear) the society of
the future and see an even more affluent 0.1% and a desperate, serf-like,
99.99%. In such an impoverished society I have no qualms that luxury items, and
assets like stocks would command a high price because demand from the 0.1%
would be strong whereas few of the 0.1% are willing sellers. Of course, it would be a “game” between the “haves” whereas the “have
not”, the serfs, would merely live from hand to mouth with no meaningful savings. Under such an
environment of disparity, many of the companies we currently know would cease
to exist (but that would not greatly affect the S&P 500 as the “losers”
would be dropped from the index). There would be no market for cheap airlines
(as the middle class would go extinct), mass leisure companies (as nobody could
afford a vacation), etc. whereas companies catering to the 0.1% would thrive
(i.e. private planes, security –to protect the 0.1% from the 99.99%-, luxury
hotel chains, luxury cars, etc.).
It goes without
saying that my “fundamental” bullish arguments are most likely baloney.
However, the bottom line is to heed the technical readings of the market. The
market knows more than all of us combined.
All in all, even though, I feel kind of uncomfortable
with the current bull market signal because I feel a deep reversal is at hand,
I see no reason to disregard it. My feelings mean nothing. Furthermore, traders
tend to say that the best trades are those most difficult to take. Will my
uneasiness be harbinger of a good trade? We will know in the coming weeks.
Nonetheless, each investor should do his homework. I am just writing my
musings. Thus, some investors might pass (we are not obliged to be batting all
the time), as the starting risk/reward is not optimal.
Sincerely,
The Dow Theorist
Wonderful post. Thank you for sharing your personal thoughts.
ReplyDeletethx for following Algyros. And do your own homework..=)
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