Dow Theory Update for May 9: McKinsey Global Institute’s report and what to expect of the Dow Theory over the next 20 years

US stocks flirting with secondary reaction

Dow Theory Update for May 9: McKinsey Global Institute’s report and what to expect of the Dow Theory over the next 20 years.

US stocks flirting with secondary reaction

US STOCKS

The primary and secondary trend (as determined by Schannep’s Dow Theory) is bullish, as explained here and here.

On April 19^th, the Transports broke out above its March 18^th, 2016 closing highs (secondary reaction highs), and, hence, according to the “Rhea/classical” Dow Theory (which only uses the Industrials and Transports in order to look for confirmations), a primary bull market was signaled.

Since April 20^th, 2016 stocks have been declining. However, the extent requirement (pullback exceeding 3%) has only been made by the Transports and hence has not been confirmed. Thus, no secondary reaction, yet or never.

By the way, the McKinsey Global Institute has released a new study entitled “Why investors may need to lower their sights”. According to the article over the next 20 years investors are to expect lower returns for stocks. In a worst case scenario, total returns, including dividends and inflation, could be as low as 4%. What is my Dow Theory take on that? Well, this would be quite close to “secular” headwind for stocks. Thus, and while nothing is sure in this life, our expectations should be modeled after the studies I made concerning the Dow Theory performance under secular bear markets. 

As explained here and here, the average gain made on each trade taken according to Schannep’s Dow Theory during secular bear markets amounts to ca. 5.5%. We also know that the duration of each transaction amounts to ca. 0.7 years (trades taken under secular bear markets tend to have shorter duration –weaker bull markets- when compared to those taken under secular bull markets). Since the Dow Theory has us invested in the market ca. 2/3 of the time, we can guestimate that under secular flat markets we can make ca. 5.5% p.a. (we should not forget that secular bear markets tend to register zero nominal growth in stock prices). If we are to make ca. 5.5% a year (excluding dividends which would accrue for the ca. 2/3 of time in the market) when the market on a secular bases does not move, it is not far fetched to assume that under a mild secular bullish condition (i.e. 4% annual total return for stocks), our Dow Theory annual performance should be in the vicinity of 5.5% (secular flat market) + 4% (annual expected return “above” flat markets) = 9.5% annual returns.

There is an alternative way to reach a similar estimate of performance. Schannep’s Dow Theory has roughly beaten buy and hold by ca. 4% (secular bull and bear markets included). 4% (hopefully) “built-in” outperformance + 4% expected annual returns for buy and hold equals = 8 % p. annum, when using Schannep’s Dow Theory. However, I have written in the past that the Dow Theory outperformance tends to be made under bear markets, and hence, we can tentatively conclude that the global 4% outperformance figure owes more to bear markets than to bull markets. Hence, it would not be outlandish to consider that the Dow Theory may likely outperform buy and hold by 5% p. annum under secular bear markets whereas under secular bull markets the outperformance is somewhat more modest (i.e. 2%), which brings us closer to an annual return for Schannep’s Dow Theory of ca. 9% p.a. for the next 20 years (under a +4% annual stock growth assumption).

Of course, all the preceding is just guesses, as nobody can predict the future. However, they are well-educated guesses, which seem to suggest than even under quite adverse conditions the Dow Theory will continue to be valuable for its followers.

GOLD AND SILVER

The primary trend and secondary trend is bullish, as reported here and here.

SLV has recently made higher closing highs which were unconfirmed by GLD. On April 29^th, GLD made higher closing highs, and hence confirmed, which tends to be positive. However, such a confirmation has taken quite a long time (more than 2 weeks), and hence, it might be indicative that a secondary reaction is coming soon.

GOLD AND SILVER MINERS ETFs

The primary and secondary trend is bullish as explained here

Sincerely,

The Dow Theorist