Dow Theory’s performance under weak cyclical bull markets
This “stress-test” saga has dealt with performance under secular bear
markets
Another environment which is detrimental to the Dow Theory is weak cyclical
bull markets.
What is a cyclical bull and bear market? I see cyclical bull/bear markets
as a long movement which is an order of magnitude less than the secular bull/bear
market. The longest movement is the secular bull/bear market. Beneath it we
find cyclical bull/bear markets. And beneath them, we have our Dow Theory
appraised primary bull/bear markets.
Thus, cyclical bull/bear markets are in both time and extent between
secular bull/bear markets and primary bull/bear markets as determined by the Dow
Theory.
In my post concerning the “stress-test” under secular bear markets, it
was shown that, in spite of secular, headwind, the Dow Theory (especially
Schannep’s) was able to remain positive and outperform buy and hold. However,
secular headwind took a toll on performance. While positive, it was less than
that attained when there was a secular bull market environment.
To begin with, how do we define “cyclical markets”? While there are lots
of diverging opinions when it comes to defining them, I’ll stick to Schannep’s
definition, which I honestly feel is very accurate and even actionable (albeit
with a lesser performance than the Dow Theory itself). According to Schannep a
cyclical bull market is one which advances 19% on both the Dow Jones
Industrial Average and the Standard & Poor's 500 over any timeframe. A
cyclical bear market is one which declines 16% on both the Dow Jones and the S&P
500 over any time-frame. Please go to Schannep’s website “thedowtheory.com” in
order to further deepen the concept of cyclical bul/bear markets and its
predictive power.
Those really intent on mastering the concept of
cyclical bull and bear markets are advised to read chapters 5 to 7 of
Schannep’s book “The Dow Theory for the 21st Century”.
Please find below a graph depicting the relationship
between secular, cyclical, and Dow Theory determined primary bull and bear
markets.
This post focuses on “weak” cyclical bull markets.
What do I mean by "weak". The average cyclical bull market has an extent of
111.1% (median 74.1%). The average duration of cyclical bull markets is 32.9
months (median 25.4 months). Thus, “normal” cyclical bull markets are supposed
to be tailwind for the Dow Theory (which operates on a lower time frame,
as the average trade lasts only 1.31 years –ca. 15.7 months-, and the average extent
of a swing amounts to ca. 46.5%). Please mind that the primary bull markets as
determined by the Dow Theory last almost exactly ½ of its cyclical peers. The
same applies to time: 15.7 months is almost ½ of 32.9 months. More food for
thought: the total number of trades of the Dow Theory roughly doubles the number
of cyclical bull markets.
However, there have been several instances of
“fibrillation” afflicting cyclical bull markets in which the extent (average
ca. 40%) and time (average ca. 3 months) of the cyclical bull market was much
lower. Such lapse of “abortive” cyclical bull markets was the norm from a
period spanning from 1929 to 1942. Hence, under the then prevailing tough
market environment (secular bear market), cyclical bull markets had to face
headwind which resulted in smaller swings.
Our question is: How did the Dow Theory fare during
such a tough period?
As I explained here, to compare the Dow Theory versus buy and hold, the right way to
compare performance is to start at a primary bear market low (start for buy and
hold), the “buy” price of the next primary bull signal (start for the Dow
Theory) and finish with the last primary bear market sell signal (end for the
Dow Theory) and the final primary bear market low following such a bear market
signal (end for buy and hold).
Since Schannep’s Dow Theory (which involves the
S&P 500) starts in 1953, we have to follow the official “Rhea/classical”
Dow Theory record in order to compare performances in the 1929-1942 period. Furthermore,
I use the Industrials in order to assess performance.
The primary bear market lows were made on July 8th,
1932 at a price of 41.22
The first Dow Theory trade started on May 24th,
1933 at a price of 84.29.
Here you have the table containing all Dow Theory
trades during this period:
The last Dow Theory trade was closed on May 13th,
1940 at a price of 137.5. The final primary bear market low following the
primary bear market signal, was made on 6/10/1940 at a price of 111.84.
Thus, buy and hold, made 171% (111.84/41.22 = 171%) during this period
spanning from 1932 to 1940 (period when the Dow Theory signaled trades).
The Dow Theory underperformed and only made 101% (see
table above).
Hence, as it was seen with secular bear markets, weak
cyclical bull markets are headwind for the Dow Theory. However, we see that it
did not self-destruct.
Furthermore, as I stress ad nauseam, the Dow Theory shines when buy and hold falters. During
the same period of “abortive” cyclical bull markets, there were of course
cyclical bear markets. Thus, during the 1929-1932 crash, there were five
cyclical bear markets (interspersed
with four cyclical abortive bull markets) with hair-curling declines
(the smallest -37.4%, the largest -53.6%). During the 1929-1932 period, when
buy and hold lost ca. 80%, the Dow Theory was flat. Thus, when making
comparisons, we have to be careful. It is true that from 1933 to 1942, when
there were trades due to a hesitant bull market condition, the Dow Theory, while making money, underperformed buy and
hold. However, if we include in our period of the market crash, the Dow Theory
was unscathed by it, whereas buy and hold was killed. By the way, strong
cyclical bear markets might also be
good for the Dow Theory, as it entails losses for buy and hold, and, more
importantly, in all likelihood, it enables Dow Theorists to re-enter the market
at a much lower price.
All in all, even under week “cyclical” bull markets,
the Dow Theory makes profits.
Sincerely,
The Dow Theorist
No comments:
Post a Comment