Friday, December 18, 2020

Dow Theory Update for December 18: Secondary trend for US bonds bearish when taking a longer time-frame

  

Primary trend unchanged for precious metals, their ETF miners, and US stocks.

 

Today we focus on US Bonds. I am writing before the close, so things might change. Readers beware.

 

Given that the primary trend has not changed for precious metals, their miners ETFs, and US stocks, please go to the following posts for the latest assessment of trends:

 

 

Gold and Silver miners ETFs

 

http://www.dowtheoryinvestment.com/2020/11/dow-theory-update-for-november-24th.html

 

Gold and Silver

 

http://www.dowtheoryinvestment.com/2020/11/dow-theory-update-for-november-28th.html


US stocks

http://www.dowtheoryinvestment.com/2020/12/dow-theory-update-for-december-8.html

 

US INTEREST RATES

General Remarks:

 

In this post, I provided a thorough explanation concerning the rationale behind my use of two alternative definitions in order to appraise secondary reactions.

 

TLT is the iShares 20 years + Treasury bond ETF. More about it here

IEF is the iShares 7-10 years Treasury bond ETF. More about it here.

Thus, TLT tracks longer-term US bonds, whereas TLT tracks middle term US bonds. A bull market in bonds entails lower interest rates. A bear market in bonds represents higher interest rates.

 

A) Market situation if one is to appraise secondary reactions not bound by the 3 weeks and 1/3 retracement dogma.

  

The primary trend was signaled as bearish on October 5th, 2020, as was explained in-depth here.

 

As of this writing, the secondary trend remains bearish, as no secondary reaction against the primary bear market can be discerned in the charts.

 

On 11/10/2020, TLT and IEF made their last recorded closing lows. From that date, a small rally set in which finished on 11/20/2020. Such a rally lasted 8 days, which is, in my opinion, not enough to declare a secondary reaction. And I say so because the extent of the rally has been quite mitigated. I could settle with a rally lasting just 8 confirmed days if its extent had been more remarkable or a significant closing high (such as the 10/14/2020 highs) had have been broken topside.

 

All in all, it is too early to declare the existence of a secondary reaction against the primary bear market.

 

However, what I see on the charts is the formation of a line (narrow range). Look at the spreadsheet below.

 


 

As you can see, the breadth of the line for TLT amounts to 4.09%. The breadth of the line for IEF amounts to 1.03%. While the line’s range is not carved in stone, when dealing with US stocks indexes, Rhea advocated for a maximum extent of 5% on a confirmed basis. Given that TLT and IEF have lower volatility than US stock indexes, we have to perform some calculations in order to account for the smaller volatility.

 

I performed the adjustment as follows.  I calculated the volatility-adjusted number comparing the standard 3% minimum movement for US stock indexes. More about this calculation here.

 

Hence, a 3% movement for US stocks indexes (i.e. S&P 500) corresponds to a 2.36% movement for TLT and 0.89% for IEF. So if we perform a rule of three, we obtain for a 5% movement in US stock indexes (the approximate maximum range), a corresponding figure of 3.93% for TLT, and 1.48% for IEF.

 

So IEF clearly fits the bill. TLT’s 4.09% range very slightly exceeds that of 3.93% (the theoretical maximum). However, given that the line has been in existence for 26 trading days (so this is slightly more than a full trading month), I feel we can safely accept 4.09% as a tight enough movement.

 

The charts below display the price action since the last recorded bull market highs to date.

 


 What are the practical implications of the line? Well, its upside penetration would imply that the secondary trend has turned bullish. So we’d have a secondary reaction against the primary bear market. Once we have a secondary reaction, we could get the setup for a primary bull market signal once prices receded without jointly breaking down the 11/10/2020 closing lows. A full explanation about lines under the “classical/Rhea” Dow Theory and how to derive buy and sell signals from them can be found here.

 

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks and 1/3 confirmed retracement in order to declare a secondary reaction.

 

The primary trend was signaled as bullish on 12/18/2018, as was explained here.

 

As you can see in the charts and in the spreadsheet below, there has been a long decline off the 8/4/2020 closing highs. As far as retracements are concerned, TLT retraced 44.76% of the previous bull market swing. On the other hand, IEF has only retraced 29.43% of the previous bull market swing. So, we still lag behind the “confirmed” 1/3 retracement. However, given that the pullback has lasted a good many days, I’d be inclined to consider that “extent” requirement has been met too. Furthermore, the fact that between 8/27/2020 and 10/2/2020, there was a line that was broken down on 10/5/2020 seems to confirm the change of the secondary trend from bullish to bearish even under a strict interpretation of the Dow Theory. All in all, one can safely conclude that on 11/10/2020 (right side of the orange rectangle) a secondary reaction was signaled. Off the 11/10/2020 lows,  a rally ensued which finished on 11/20/2020. This rally has two consequences:

 


 

 a) It resulted in a line (as more days passed within the range made in the first 8 trading days). If it were jointly broken up, I’d interpret it, as a change of the secondary trend from bearish to, once again, bullish.

 

b) It set up TLT and IEF for a primary bear market signal.

 

Sincerely,

 

 

Manuel Blay

(One Dow Theorist)

 

 

 

 

 

 

 

 

 

 

 

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