Dow Theory Review for 2014

US Stocks

Let’s briefly recap how our Dow Theory analysis fared in 2014. Did we do a good job at determining the primary trend of the markets? 2013, as explained here was a good year for those applying the Dow Theory to stocks, gold, silver and their miners. 2014 has been a good year too (by avoiding losses with losers, and by winning with the winners).

Today I focus on US stocks. In the coming days, I will review how gold, silver and their ETF miners fared when traded in pursuance with the Dow Theory.

The year began on January 2 with an ongoing primary bull market, which had been reconfirmed on November 13th,2013, as you can read here.

 

This primary bull market signal lasted until October 10th, when a primary bear market was signaled, as explained here.

The long position was closed with profits, as explained here.

For the sake of completeness, I must say that Schannep, of “thedowtheory.com” interpreted the Dow Theory in a different fashion which resulted in his not signaling a primary bear market on October 10, 2014. Thus, Schannep remained fully invested. Our friendly discrepancy gave rise to a “saga” wherein I analyzed the reasons advocated by Schannep and I. You can find the five chapters of the saga here:

http://www.dowtheoryinvestment.com/2014/11/dow-theory-special-issue-schannep-and-i.html

here:

http://www.dowtheoryinvestment.com/2014/11/dow-theory-special-issue-schannep-and-i_25.html

here:

http://www.dowtheoryinvestment.com/2014/12/dow-theory-special-issue-schannep-and-i.html

  here:

http://www.dowtheoryinvestment.com/2014/12/dow-theory-special-issue-schannep-and-i_9.html

 and here:

 http://www.dowtheoryinvestment.com/2015/02/dow-theory-special-issue-schannep-and-i.html

 

The primary bear market was short-lived and on October 31, a new primary bull market was signaled, as explained here.

This primary bull market remains in force as of this writing.

Here you have a chart displaying 2014, from January 2nd (first trading day) to December 31st. The orange rectangle displays the period we were sitting on the sidelines due to the primary bear market signal.

The trend is your friend. Don't fight it!

Now let's have a look at profits, as shown in the spreadsheet:

  

	BUY AND HOLD			DOW THEORY
	SPY			SPY
Jan 2	182.92		Jan 2	182.92	entry
Dec 31	205.54		Oct 10 Primary bear mkt	190.54	exit
Proft	0.1236		Profit 1 (realized)	0.042
			Oct 31 Primar bull mkt	201.66	entry
			Dec 31	205.54	end of 2014
			Profit 2 (unrealized)	0.0192
			Nominal profit (1+2)	0.0612
			Capitalised profit	0.062
Dow Theory outpeformance		-0.0616

Please mind that the real profits made by the investors are those that I label "capitalised". This is the money you'd have made starting with 100 units, cashing out 104.2 units at the Oct 10 exit and reinvesting the 104.2 units at the second buy signal on Oct 31. As you can see the Dow Theory made 6.2%. Nonetheless, buy and hold managed to make 12.36%. 

However we should put this numbers in perspective (don’t get too carried away by “buy and hold”)

If we adjust total returns by taking into account the maximum drawdown suffered during 2014, then buy and hold begins to shine a little bit less. A proper measure of performance (that takes into account risk, losses), is to obtain the ratio of total returns versus maximum drawdown. As you will see on the spreadsheets below, when we adjust for risk, buy and hold has a more modest outperformance. 

MAX Drawdown 2014 SPY buy and hold				MAX Drawdown 2014 SPY  Dow Theory
	Price	date			Price	date
Closing High	201.82	09/18/2014		Closing High	201.82	09/18/2014
Closing low	186.43	10/15/2014		Exit	190.54	10/10/2014
Max Drawdown	-0.07625607			Max Drawdown	-0.055891388

So we see that buy and hold had to endure a deeper drawdown than that of the Dow Theory (and a -7.62% drawdown is certainly a very mild drawdown according to historical standards).

Now, if we divide total performance by the largest drawdown, we obtain the risk adjusted measure of performance:

Ratio total return/Max DD for year 2014				Ratio total return/Max DD for year 2014
	buy and hold				Dow Theory
total return	12.36			total return	6.12
max DD	7.625607			max DD	5.55891
Ratio	1.620854576			Ratio	1.100935255

So, even in a very lenient year (as far maximum drawdown is concerned) when we adjust for risk, we see that buy and hold, outperformed the Dow Theory but by a smaller degree than raw performance.

And please bear in mind that the deeper the drawdown, the more degraded the risk-adjusted performance of buy and hold. I give you an example that, alas, happens every now and then in the stock market. Let’s imagine that the October 2014 drawdown had been much deeper, let’s say 15% (which is not a rare occurrence). In such case, the Dow Theory, on a risk-adjusted basis would have outperformed buy and hold.

The bottom line is: focus on avoiding risk (losses). Don’t get blinded by performance. Performance will come, once you learn to contain losses. 

Thus, for those thinking that buy and hold was better than trying to time the market, please heed this: Don't get blinded with 2014 (or 2013, for that matter). Please bear in mind that in “good” years buy and hold outperforms any timing device which tries to follow the primary trend. Furthermore, as I explained in my post "How often does the Dow Theory outperform Buy and Hold", we have to bear in mind that 41.2% of any given year the Dow Theory underperforms buy and hold. The global outperformance of the Dow Theory (be it "classical" or Schannep's) is made in relatively few years (normally, when markets are weak).


You can see what I have stated many times: it is close to impossible to beat buy and hold when there is a strong trend, since by definition timing devices (such as the Dow Theory) will always get aboard too late or exit prematurely (when there is a failed signal). However, as I have said ad nauseam in past posts, the Dow Theory manages to outperform buy and hold (both in terms of performance and in terms of reduced volatility) thanks to the “bad” times. In other words, the outperformance comes from cutting losses short. Thanks to the Dow Theory we manage to win slightly less than buy and hold when the sun shines, but we lose much, much less during bad times. The overall result is slight outperformance and, more importantly, dramatically reduced drawdowns. You are referred to the “Face off” saga for more information.

Conclusion: the Dow Theory did a good job keeping us most of the year on the right side of the market. While many fundamentalists and macro analysts were predicting a stock market decline (as they did in 2013 during this most hated bull market), the Dow Theory, impervious to ego or fundamentally-based ideas, told us that the trend was up. Out of 12 months, the Dow Theory had us invested in the market 11 months and some days. I pay with pleasure the price of being some weeks out of the market (and foregoing the corresponding performance) as an insurance against a real primary bear market. 

Gold, Silver and their miners ETFs.

Gold and Silver

2014 began with an ongoing primary bear market in gold and silver which had been signaled by this blogger truly yours on December 20^th, 2012 (as explained here). The primary bear market signal was not reversed until January 16th, 2015, as explained here.

2014 is over and precious metals have suffered losses during that year. Thus, we can talk of a successful primary bear market signal, in the sense that investors have been spared losses. I insist; the beauty of the Dow Theory lies not so much in “outperforming” nicely ascending markets (as stocks in 2013 and 2014) but rather in determining the onset of a primary bear market soon enough so that losses are avoided. 

Here you have a chart displaying 2014 (GLD), from January 2nd (first trading day) to December 31st.

Out of the market, it was a primary bear market for GLD

Now let's have a look at losses, as shown in the spreadsheet:

	BUY AND HOLD			DOW THEORY
	GLD			GLD
Jan 2	118.00		Jan 2
dec 31	113.58		dec 31	out of the market
loss	-0.03746		loss	No loss

Dow Theory outpeformance

0.03746

Well, since according to the Dow Theory we were on the sidelines during the whole year, no losses were incurred by those investors who decided to follow the trend versus -3.746 % lost by buy and hold (and with hair-curling temporary declines far exceeding the overall -3.746% loss). So the outperformance (as loss avoided) for the Dow Theory is clear. Furthermore, you have to bear in mind that during 2013 we were also on the sidelines, hence avoiding a whopping -28.83% loss for that year.

As to SLV, Here you have a chart displaying 2013, from January 2nd (first trading day) to December 31st. 

 

SLV: Same as GLD. We didn't toch it.

Now let's have a look at profits, as shown in the spreadsheet:

	BUY AND HOLD			DOW THEORY
	SLV			SLV
Jan 2	19.23		Jan 2
dec 31	15.06		dec 31	out of the market
loss	-0.21684		loss	No loss

Dow Theory outpeformance

0.21684

Since according to the Dow Theory we were on the sidelines during the whole year, no losses were incurred by those investors who decided to follow the trend versus -21.684% lost by buy and hold. So the outperformance (as loss avoided) for the Dow Theory is clear. Furthermore, you have to bear in mind that during 2013 we were also on the sidelines, hence avoiding a whopping -37.46% loss for that year.

If you were skeptical about my claims that the Dow Theory outperformance is built upon avoiding losses rather than by making outsized gains (i.e. by beating buy and hold and good years) here you have the living proof with precious metals. Thus, those that might be feeling unsatisfied with the relatively modest performance by stock indices traded in pursuance with the Dow Theory during 2013 and 2014 versus buy and hold, now can see the looks of a real bear market and how it can result in drawdowns exceeding 50% (as with silver).

Gold and Silver miners

2014 began with an ongoing primary bear market in gold and silver miners ETFs (GDX and SIL) which had been signaled by this blogger truly yours on November 20^th, 2013, as explained here and here.

Thus, we stood on the sidelines the whole year, as the primary bear market was not reversed during that year (it has been recently reversed by a primary bull market signal on January 12, 2015)

 

Here you have a chart displaying 2013 (GDX), from January 2nd (first trading day) to today December 31st. 

Whole 2014 under a primary bear market spell: No positions taken

 

Now let's have a look at profits, as shown in the spreadsheet:

	BUY AND HOLD			DOW THEORY
	GDX			GDX
Jan 2	22.03		Jan 2
dec 31	18.38		dec 31	out of the market
loss	-0.1657		loss	No loss

Dow Theory outpeformance

0.1657

So the Dow Theory helped us avoid a -16.57% loss in GDX. 

And what happened with SIL?

Here you have the chart for 2014:

SIL also on a bear market. No positions takes during 2014

We also stood on the sidelines for the whole year 2014, and hence we kept our powder dry. Let’s have a look at SIL’s performance  for buy and hold versus the Dow Theory:

	BUY AND HOLD			DOW THEORY
	SIL			SIL
Jan 2	11.62		Jan 2
dec 31	9.26		dec 31	out of the market
loss	-0.2031		loss	No loss

Dow Theory outpeformance

0.2031

So the Dow Theory helped us avoid a -20.31% loss in SIL. 

Conclusions:

When it comes to precious metals ETFs, it is clear that the Dow Theory did a good job at keeping us safe. Once again, you can see that the Dow Theory outperformance is bred by bear markets by avoiding drawdowns. 

Furthermore, you can see that signals are not displayed so often. For the precious metals universe no signal was flashed at all during 2014.

Finally, if you look at the precious metals charts you will see that some pretty strong rallies occurred which tricked several market analysts (Russell, and others come to my mind) into becoming prematurely bullish. You can see that the Dow Theory was not tricked at all, because it has the uncanny ability to tell the difference between a secondary reaction and the real thing (a primary bull market).

No more words are necessary as the facts speak for themselves.

Sincerely,

The Dow Theorist