Dow Theory Update for April 17: More thoughts concerning the recently demised bull swing and the current primary bear market signal

US STOCKS

The primary trend turned bearish on April 9, as was explained here, and more in depth here

Thus, the primary bull market that was signaled on November 21^st, 2016 has come to an end. At this moment we cannot know whether the current primary bear market signal is going to be a “good one” (that is that further declines ensue, and that the next primary bull market signal is given at a lower price that the exit price at the close of April 9^th, 2018) or a "bad" one.

What we do know, though, is that the trade that has been closed has lasted 505 calendar days (entry at the close of November 21^st, 2016, exit at the close of April 9^th, 2018). As was explained here, the average trade taken in pursuance of Schannep’s Dow Theory has had an average duration of 479 days. So we can say that the current trade has been a quite standard one. Furthermore, and since the market has made until recently all-time highs, it is reasonable to assume that we are now under a secular bull market. The trend when established with weekly bars (and applying Dow Theory rules) is clearly bullish which also seems to advocate for a secular bull market. The average trade duration under secular bull markets amounts to 864 days. Against this “secular” benchmark, the recently closed trade falls somewhat short of the average. In any instance, any way you cut it, we, at long last, have had a “normal” and profitable trade. Please mind that the last two preceding trades had an abnormal duration (too short) which prompted me to write several posts, which shed some light as to the unlikelihood of being decimated by abnormal trades, which you can read here and here. As an aside, you may remember that in my last post I was expressing the fear (when buying) and greed (when regretting to sell) that plague me when I have to act upon the Dow Theory signals. The posts I write when I am besieged by feelings serve me to assuage them and to have the courage to stick to the rules.

 

 

As to the gains made. The S&P 500 closed at 2198.18 on November 21^st, 2016. On April 9^th, 2018 it closed at 2613.16 which translates into a gain of 18.87%. Thus, this trade has been a decent winner. The average trade taken in pursuance of Schannep’s Dow Theory amounts to 22.07%). Thus, the recently closed trade has been slightly under par. Under secular bull markets the average trade amounts to a whooping 53.37%.

From the top made on 1/26/2018 (at 2872.87) to the close of April 9^th, 2018 (bear market signal) at 2613.16, the S&P 500 declined -9.04 %. This is slightly more than the average decline from thetop which is ca., 7.7%. Hence, our decline has been slightly more than average but close enough to the top not to decimate portfolios.

If we consider the bottom of the previous primary bear market (made on 11/4/2016 at 2097.94 for the S&P 500) and the top of the recently demised one (made on 1/26/2018 at 2872.87), the total bull swing amounted to 36.93 % for the S&P 500.

If we consider the total advance from the close of November 21^st 2016 (day of the primary bull market signal) to the top made on January 26st, 2018, the S&P 500 advanced 30.69%, which is quite close to the historical average. From 1954 to 2008 the average further advance until making a top following a primary bull market signal was a solid 37.98%. However, since 2009 we have had sputtering bullish action and subsequent advances following a primary bull market signal amounted to a much modest 12.16%. All in all, the advance following the primary bull market signal until the top was more like the “old” good swings than the action seen after 2009. Some readers might think that I am getting things wrong, since the market staged a tremendous advance since 2009. However, such an advance has not been “clean”, as rallies following primary bull market signals lacked follow through (and the same applies to sell signals) and have been interrupted by secondary reactions which degenerated into primary bear market signals. More thoughts as to the repercussions for actual trading of such mitigated market action here.

Here you have a chart depicting the market action since the primary bull market signal of November 21st. 2016 until April 9th, 2018. The horizontal lines on the lest and the right of the charts display the primary bull market signal (left) and the primary bear market signal (right). The red rectangles display secondary reactions. The first one was resolved successfully in favor of the ongoing bull market, the second one (right side) became a primary bear market signal:

 

A full and quite long primary bull market

 

Please mind that the subsequent advance until the top following a primary bull market signal is a vital statistic. We need follow through for signals to be profitable.

Now comes the one million question: How long are US indices likely to go down? Are we going to be whipsawed?

The answer is that nobody knows.

I only know the following: Since 1960 subsequent declines following a primary bear market signal averaged -12.17%. In other words, after the close of the day where a primary bear market signal is given until the close of the final bottom day, the S&P 500 has historically declined by an average -12.17%. Since we know that our average “buy” signal (primary bull market) tends to be on average at ca. 7.4% from the bottom, a decline of ca. -12% gives us “on average” the opportunity to take a new trade at ca. -5% cheaper prices. This is one of the two sources of the Dow Theory outperformance. Of course, if there is a severe decline (i.e. -30% or crash conditions of -50% or more) our entry price will be even in better terms. The other “source” of Dow Theory outperformance versus buy and hold is losing “on average” only ca. -8% from the top, whereas buy and hold has to endure average declines which tend to be larger.

I also do know that in the most recent past (since 2009 to present) further declines following a primary bear market signal have been more muted (only -8.66%) which partially accounts for more whipsawing and lower performance seen in the last few years. I wrote “partially” because not only have been subsequent declines until the bottom more muted but also subsequent advances following a primary bull market signal, which has been a challenging environment for the Dow theory (and for all trend followers, hence the underperformance of most hedge funds in recent years).

All in all, if the subsequent decline until a bottom is made is to resemble the averages of the recent past, we will be likely forced to buy (following the next primary bull market signal) at a slightly higher price than we sold. This is not to imply a future losing trade, but merely, a whipsaw (which of course is annoying). If the decline were to resemble the average decline since the 1960’s then we would be very likely reentering at a lower price than we exited which would help us build outperformance.

I have “ad nauseam” postulated that the Dow Theory outperforms buy and hold when the going gets tough. Mildly ascending markets interrupted by mild corrections are not the best environment for the Dow Theory (or for any trend following system whatsoever). Thus, a hefty decline is what we really need in order to make up for the underperformance versus buy and hold since 2009. Are we in the vicinity of a big decline? Nobody knows. What I know is:

a)     When the Dow Theory underperforms buy and hold, I get, nonetheless, positive results (no decimation).

b)    When the Dow Theory outperforms buy and hold, I get outstanding results (whereas buy and hold gets annihilated).

Thus, nobody should feel “uncomfortable” with relatively long periods of underperformance. The goal in investing is to survive in challeging conditions and be able to capitalize on the good market environments. If the periods of underperformance are, nonetheless, positive, we have to have to courage to stick to the rules.  

The cyclical bull market that got started in 2011 is statistically very old. This might imply that the odds for a serious decline (“serious” being at least meeting Schannep’s definition of a cyclical bear market, which is a -16% confirmed decline) should be higher now than, for instance, three years ago. More about cyclical bull/bear markets as per Schannep himself here.

One important thing, though. Our primary bear market has been (until now) defined by the “Rhea/classical” Dow Theory. Schannep’s Dow Theory has not yet signaled a primary bear market yet. Please remember that under Schannep’s Dow Theory whichever Dow Theory (be it “classical” or his) gives first a signal, such a signal is to be followed.  Hence, we are facing the following scenarios:

a)     Schannep’s Dow Theory signals primary bear market too (S&P 500 finally violating its 2/8/2018 closing lows). Outcome: Nothing changes. The “two” Dow Theories get in sync.

b)    Schannep’s Dow Theory refuses to signal primary bear market but indices do not exceed their January 2018 closing highs. Outcome: Nothing changes. We remain on the sidelines.

c)     Schannep’s Dow Theory refuses to signal primary bear market but indices do not exceed their January 2018 closing highs and the Industrials and Transports, as per classical Dow Theory develop secondary bullish reaction, setup for primary bull market signal and finally signal changed of trend from bearish to bullish. Outcome: We’d follow the “buy” signal given by the “Rhea/classical” Dow Theory irrespective of the meandering of Schannep’s Dow Theory.

d)    Schannep’s Dow Theory reconfirms primary bull market (which implies the three indices bettering their primary bull market highs). Outcome: Such a movement would also entail, the Industrials and Transports exceeding their respective primary bull market closing highs, which is a “buy” signal to be followed and which would change the primary trend as per the “Rhea/classical” Dow Theory from bearish to bullish.

So now we have to look for the development of the next secondary reaction (appraised by the “Rhea/classical” Dow Theory. For the time being, we are far from that.

GOLD AND SILVER

In spite of all the turbulences that seem to afflict markets. The precious metals have not even changed their secondary trends.

The primary trend was declared bearish on July 7^th, 2017, as explained here and here

The secondary trend is bullish, as was profusely explained here.

The pullback that got started on September 8^th, 2017 has unambiguously setup SLV and GLD for a primary bull market. A quite different issue is whether the signal will be ever given.  An in-depth explanation here. Please mind that a “setup” is not the actual signal. GLD has broken up above the secondary reaction closing highs (on 1/24/2018, 2/14/2018, and 2/15/2018) unconfirmed by SLV. Thus, no primary bull market has been signaled and the primary trend remains unchanged.

GOLD AND SILVER MINERS EFTs

Precious metals (both the stocks ETFs anb the precious metals themselves remain listless for many months now. Hence trends have not changed.

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

The secondary trend is bullish as explained here

For the same reasons given when analyzing SLV and GLD, no primary bull market has been signaled for SIL and GDX, as explained here. GDX did not better its secondary reaction closing highs by a hair, but it failed to do so. Furthermore, SIL was very far from its secondary reaction closing highs.

On 11/10/2017 SIL violated its primary bear market closing lows (red arrow on the right side of the chart). GDX has not confirmed. Lack of confirmation implies that the primary bear market has not been reconfirmed, and, as with GLD and SLV,the longer it takes for GDX to confirm the higher the likelihood that the primary bear market may be nearing its end.

Therefore, the current situation remains unchanged. We have a primary bear market signaled on 10/04/2016 (more than one year old, another candle to light). There is an ongoing secondary reaction against the primary bear market and a setup for a primary bull market.

Sincerely,

The Dow Theorist

Dow Theory Update for April 10: Dissecting the primary bear market signal for US stocks given on April 9th

Primary and secondary trend for precious metals and their ETFs unchanged

US STOCKS

Trading is not easy. When I took the buy signal given on a now distant November 21^st, 2016 (more about that signal here and here.), I was fearful, as a recent whipsaw prompted me to think that the then new signal was doomed to fail (“fail” means that I would be stopped out through a sell signal at a lower price than I was then buying). I was disciplined and, though fearful, I did not override the Dow Theory and honored the signal.

After a successful ride that lasted more than ca. one and a half year, yesterday we got a primary bear market signal which, at least for me, is tantamount to a “sell”. Go figure! This time I was fearful to sell, because I thought that this new sell signal (without the S&P 500 participation) is doomed to fail ("fail" would mean that the next "buy" is given at a higher level than yesterday's close). So when it was time to buy I was afraid to incur a loss, and when, as per the Dow Theory, it is time to sell, I am afraid to miss future profits. 

If such feelings besiege me, a person immersed in the Dow Theory since almost 20 years and true believer, can you imagine how difficult is to trade any trading system? It is not so easy to keep emotions at bay. This is why the saying goes "it is easier to talk (or write) about money than really making it"

Let’s analyze the current signal. To this end, let’s make a brief recap of Schannep’s Dow Theory.

Schannep’s Dow Theory has several rules. On the one hand, it has its own specific rules which make it different from the “classical” Dow Theory. Thus, it avails itself of three indices (INDU, TRANS, S&P 500), it has a specific definition of secondary reaction (no vague concepts, a hard and fast rule for both time and extent), etc. From Schannep’s set of rules we derive actual “buy” (primary bull market) and “sell” (primary bear market) signals. Schannep’s record show that usually his own rules are more responsive to changing market conditions than the “Rhea/classical” Dow Theory. In other words, buy and sell signals are given earlier and, more importantly, performance does not suffer. Schannep’s rules have historically resulted in more profits and less drawdowns. The most comprehensive comparison between both Dow Theory "flavors" is to be found here.

However, Schannep’s Dow Theory does not exclude the use of the “classical Dow Theory“ rules. Thus, Schannep keeps an eye on the development of secondary reactions, rallies, pullbacks, etc, when appraised exclusively using two indices (INDU and TRAN) and with the “rules” of the classical Dow Theory. In the rare instances where the “classical” Dow Theory is more responsive than “Schannep’s Dow Theory” (as it was the case yesterday), one takes the “classical” signal. Thus, Schannep is eclectic. If the “classical” Dow Theory gives a signal, such a signal is taken.

In our current juncture, the “classical” Dow Theory has given such a sell signal, whereas Schannep's Dow Theory has not. This implies that we have to analyze the markets under the prism of the classical Dow Theory.

The issue with the classical Dow Theory is that it lacks a specific rule to appraise secondary reactions. Rhea talks of “an important decline in a bull market or advance in a bear market, usually lasting from three weeks to as many months” (emphasis supplied).

The word “usually” means that even Rhea did not give much credence to the three weeks minimum time requirement. On page 61 of my “The Dow Theory” edition (Fraser Books 1993) Rhea goes on to say “no two students would agree on any rule for selecting and tabulating the important secondary reactions which have occurred during the 35-year history of the fluctuations of the railroad and industrials stock averages”.

He seems to accept (albeit not always) secondary reactions which last less than three weeks when, on the same page, he says that “one test eliminated all reactions as negligible which did not extent more than 15 days, with the result that many really important movements were eliminated”.

Schannep himself, when applying the “classical” Dow Theory tends to demand three weeks, albeit he allows some flexibility (as Rhea did). This is one of the instances where Schannep determines the existence of a secondary reaction for the Industrials and Transports (bear in mind that under “classical” Dow Theory we don’t use the S&P 500) when the three weeks time requirement has not been strictly met.

I display below a chart of the Industrials (top) and the Transports (bottom). The primary bull market top for the Industrials was made on January 26^th, 2018 (Friday). As was explained here, Schannep considers the two days of the weekend as being part and parcel of the calendar days to be counted from the top. In other words, the last day of ascending prices was January 26^th. Saturday 27^th, and Sunday 28^th, are counted as calendar days belonging to the interruption of the primary bull market. This aspect vital for the appraisal of the current secondary reaction was dealt with in depth here and here.

The decline stopped on February 8^th, 2018. Thus the decline for the Industrials lasted 9 trading days, and more importantly, 13 calendar days. We almost had two full weeks of decline both in terms of calendar and trading days.

What about the Transports? Well the last recorded closing highs for the Transports were made on January 12^th, 2018. The closing lows of the decline were made on February 8^th, 2018. Thus, the Transports decline ostensibly more than 3 weeks (in calendar days) and 20 trading days. In other words, the Transports decline more than met the most stringent requirements for a secondary reaction under the “classical” Dow Theory.

Given that the Transports more than exceeded the 3 weeks benchmark, and given that the Industrials declined for almost two weeks, and (this is my personal view) given that the decline was important, as the Industrials declined by -10.4% and the Transports by -10.9%, it is not outlandish to declare the existence of a secondary reaction for the Industrials and Transports.

From the February 8^th, 2018 closing lows both the Industrials and Transports rallied more than three percent, which set up stocks under the “Rhea/classical” Dow Theory for a primary bear market signal. More about the setup here.

The rally that followed the secondary reaction lows is displayed by the blue rectangles on the charts below.

On March 23^rd, 2018 the Industrials violated their secondary reaction closing lows (red arrow on the top chart) unconfirmed by the Transports. The Transports confirmed yesterday, April 9^th (red arrow on the bottom charts), thereby giving us a primary bear market signal under the “Rhea/classical” Dow Theory.

As I explained above, Schannep’s Dow Theory also acts upon the signals that are given by the classical Dow Theory. Hence, this signal is fully meaningful even though under the specific and clear-cut rules of “Schannep’s Dow Theory” no primary bear market has been signaled yet, as the S&P 500 remains (as of this writing) above its secondary reaction closing lows. By the way, under the rules of Schannep’s Dow Theory there is no doubt as to the existence of a secondary reaction, as was explained in depth here:

Here you have the chart that depicts the latest developments. The orange rectangles show the secondary reaction, the blue rectangles show the rally that followed the secondary reaction closing lows which set up stocks for a primary bear market, and the red horizontal lines display the relevant levels (secondary reaction lows) to be jointly violated in order to have a primary bear market signal. 

Primary bear market signal under the "classical" Dow Theory

There is much more to be written, namely:

·       Duration of the last “buy” signal.

·       Realized gains.

·       Maximum advance from the entry price.

·       Decline from the top.

·       What to expect from the current bear market. How deep may it go? Whipsawed?

Hopefully, before the end of this week I will be able to write a new post.

GOLD AND SILVER

In spite of all the turbulences that seem to afflict markets. The precious metals have not even changed their secondary trends.

The primary trend was declared bearish on July 7^th, 2017, as explained here and here

The secondary trend is bullish, as was profusely explained here.

The pullback that got started on September 8^th, 2017 has unambiguously setup SLV and GLD for a primary bull market. A quite different issue is whether the signal will be ever given.  An in-depth explanation here. Please mind that a “setup” is not the actual signal. GLD has broken up above the secondary reaction closing highs (on 1/24/2018, 2/14/2018, and 2/15/2018) unconfirmed by SLV. Thus, no primary bull market has been signaled and the primary trend remains unchanged.

GOLD AND SILVER MINERS EFTs

Precious metals (both the stocks ETFs anb the precious metals themselves remain listless for many months now. Hence trends have not changed.

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

The secondary trend is bullish as explained here

For the same reasons given when analyzing SLV and GLD, no primary bull market has been signaled for SIL and GDX, as explained here. GDX did not better its secondary reaction closing highs by a hair, but it failed to do so. Furthermore, SIL was very far from its secondary reaction closing highs.

On 11/10/2017 SIL violated its primary bear market closing lows (red arrow on the right side of the chart). GDX has not confirmed. Lack of confirmation implies that the primary bear market has not been reconfirmed, and, as with GLD and SLV,the longer it takes for GDX to confirm the higher the likelihood that the primary bear market may be nearing its end.

Therefore, the current situation remains unchanged. We have a primary bear market signaled on 10/04/2016 (more than one year old, another candle to light). There is an ongoing secondary reaction against the primary bear market and a setup for a primary bull market.

Sincerely,

The Dow Theorist