Tuesday, March 28, 2017

Dow Theory Update for March 28: Have we seen the top for US stocks?





Subsequent advances following a primary bull market signal and what does this means for us now


I am writing before the close of March 28th. So things might change (unlikely) after the close. So readers beware and do your own homework.

US STOCKS

The primary and secondary trend is bullish since November 21st, 2016, as explained here and here.


On March 1, 2017, the Industrials, Transports and SPY made jointly higher highs. Since then the Industrials, Transports and SPY have declined. The decline has hitherto lasted 14 days. The Industrials and Transports have declined -2.67% and -6.91% respectively. The SPY has declined -2.56% (The S&P 500 – 2-27%).

Under Schannep’s Dow Theory, at least two indices should decline more than 3% in order to declare the existence of a secondary reaction (extent requirement). Hence, given that only the Transports have declined more than 3%, the extent requirement has not been met.

As far as time is concerned, under Schannep’s Dow Theory, a secondary reaction must last a minimum of 10 calendar days on 2 of the 3 indices with at least 8 trading days as the average of all three indices. The Transports have declined for 14 trading days, whereas the Industrials and SPY have declined for 18 trading days. Hence, the time requirement has been amply met.

Here you have an updated chart.

In spite of the recent decline: No secondary reaction yet


Now let’s move on. While we cannot declare the existence of a secondary reaction as the extent requirement has not been met, we can ask ourselves whether the closing highs of March 1st, 2017 are the last gasp of the current primary bull market which was signaled on November 21st, 2016.

While noting is certain let’s do some maths. As I have written in the past, since 2009 the US stock market, while certainly advancing has done so in a “fibrillation”mode, plenty of noise, with many false breakups and breakdowns. Since I don’t like to make statements not backed by figures, I wrote in the past the primary bear market signals had in the past significant (i.e. more than 12% average further decline) follow thru. Since 2010 such follow thru has been muted and resulted in more whipsaws (average further decline following the primary bear market signal of ca. -4%, as explained here)


What about subsequent advances following a primary bull market signal? Well, I also have some hard and fast figures for you. From 1954 to 2008 the average further advance following a primary bull market signal amounted to 37.98% (median 27.03%). In other words, there was ample bullish action before the primary bull market signal fizzled out. Since we know that, on average, following a primary bull market top, the primary bear market signal (exit) is flashed at ca. 7-8% below the market top, there was an ample margin (37.98% upswing versus 7-8% downswing leading to the exit) to have profitable trades.


What has happened from 2009 to date? Well, as with subsequent declines following primary bear market signals, subsequent advances following primary bull market signals have been muted. My spreadsheet tells me that from 2009 to date, the further advance following primary bull market signals amounted to a mere 12.16% (median 7.6%). Hence, the subsequent advance has been cut in roughly three (37.98% versus 12.16%). No wonder we see “fibrillation”. Sell signals lack follow through and buy signals are likewise afflicted by the same ailment. This results in:

            a) More whipsaws.

b) Shorter duration of each trade (thus, we are suffering trades which last only 2-4 months versus more than 1 year (which used to be usual).

            c) More trades.

However, it is important to note that even under such sputtering bullish action, further advances following a primary bull market signal of ca. 12% are sufficient to result in modestly winning trades. We know that exits tend to be between 7-8% below the top. If following a primary bull market signal we make 12% and from that point we lose 8% we still have ca. 4% left. Of course, this is far from stellar returns, and far from the smooth ride which the Dow Theory tended to give us in the past (less than one trade per annum, 4% outperformance versus buy and hold). Now, we have to suffer more trades and subpar performance (though not losing one’s shirt)

The million question is: Will the market action we have been seeing since 2009 be the new normal in the future? Or it is just an aberration? As I wrote here, I feel we are seeing an aberration, albeit a very painful one in the short run (“short run” for long term trading methods like the Dow Theory means quite a lot of time, since we are not day trading, and a couple of bad trades may take quite a lot of time to be reversed) for those not intimately acquainted with the Dow Theory. Periods of even 10 years of underperformance versus buy and hold are not a rare occurrence. Furthermore, I wrote here that on any given year, the odds favor the Dow Theory underperformance.
 

We should always bear in mind that the Dow Theory outperformance is made when buy and hold has bad years. In other words, the Dow Theory tends to underperform (but not lose) on the “good” years for buy and hold, and outperforms (by cutting losses short) when the “bad” times begin. This is why it takes fortitude to stick to any trend following method (Dow Theory included). When one looks at “track records” one tends to get excited when looking at the outperformance (in the long run) of ca. 4% and the dramatic reduction of drawdowns of the Dow Theory (ca. 10% versus 50%) versus buy and hold. However, in real time most of the time buy and hold “shines” whereas the Dow Theory lags. And “in real time” it hurts, and investors tend to throw the towel.

Let’s go back to our current trade. Our entry price was at 220.15 (SPY on November 21st, 2016). The March 1st closing highs were 239.78. This is a further advance following the primary bull market signal of 8.9%, which is not that far from the average market advance seen since 2009. Furthermore, such an advance is greater than the mean of 7.6% seen since 2009. All in all, if the “new fibrillation normal” seen since 2009 is to be applied to this trade, I fear that soon we will see a new secondary reaction which, regretfully, may end in a new primary bear market signal.

If, on the other hand, we were back to the “old normal”, with generous further advances of ca. 37.98%, then the odds would favor no primary bear signal in sight.

There are two contradictory factors which advocate for opposite outcomes. The primary trend when appraised by the Dow Theory by using weekly bars is bullish. Such trends based on weekly bars have lasted many years in the past. Thus, the weekly chart is strongly bullish which is tailwind for the current trade.

On the other hand, the current cyclical bull market (more about them and their definition on Schannep’s website, “thedowtheory.com” and my own analysis here) is getting really old (it got started on 2011). While in “real time” in is very difficult to predict the demise of the current cyclical bull market, as “in real time”, there is ca. 50% odds for the cyclical market to continue some extra months, it is clear that a -16% confirmed decline that kills the current cyclical market is more than overdue.
  
Thus, and I make no pretense of being omniscient, we are under a very complicated technical situation. The Dow Theory (both Schannep’s and the “Rhea/Classical”) are bullish. If we apply the Dow Theory to weekly bars, we also get a bullish reading (tailwind). However, the cyclical bull market is very old, and if past market patterns (fibrillation) are to continue for the current trade, we may have likely seen all possible advance following the primary bull market of November 21st, 2016.

Personally, I live and die by the Dow Theory applied to daily bars. I wouldn’t qualify the ancillary technical information I have given as a distraction (it can be useful for some traders and gives some sense of perspective), but, for me, and in order to pull triggers (buy/sell) I just need Schannep’s Dow Theory and the courage to stick to it. Too much detail, too much information in many instances is counterproductive (at least for me). Too many degrees of freedom. 


GOLD AND SILVER

The primary trend is bearish, as was explained here and here. The primary bear market was signaled on September 30rd, 2016.


The secondary trend is bullish (secondary bullish reaction against the primary bear market), as explained here.

As was explained here, SLV and GLD have set up for a primary bull market signal. Please mind that "setup" is not tantamount to the actual signal. If the last recorded primary bear market lows were jointly revisited, the primary bear market would be reconfirmed.

 In the last few days we have seen a confirmed rally. Nonetheless, such rally hasn’t changed the technical picture.

As an aside, it is worth mentioning that the primary trend when using weekly bars is bearish, which tends to be headwind for any meaningful bullish action.

GOLD AND SILVER MINERS EFTs

The primary trend is bearish, as was explained here and here.

The secondary trend is bullish as explained here

As was explained here, SIL and GDX have set up for a primary bull market signal.
 
If the last recorded primary bear market lows were jointly revisited, the primary bear market would be reconfirmed.

In the last few days we have seen a confirmed rally. Nonetheless, such rally hasn’t changed the technical picture.

As an aside, it is worth mentioning that the primary trend when using weekly bars is bearish, which tends to be headwind for any meaningful bullish action.


Sincerely,
The Dow Theorist

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