Dow Theory Special Issue for February 4: It is not a primary bear market…

…In spite of what other Dow Theorists may say

Last Friday, January 30, the Transports violated their secondary reaction lows, and, hence confirmed the Industrials which had done so January 28. As reported by Mark Hulbert  of “marketwatch.com”, the Dow Theory is now “flashing” a “sell” signal. In his opinion (apparently backed by other Dow Theorists) the confirmed violation of the January 15 closing lows constituted a primary bear market signal under the Dow Theory.

You can find Mark Hulbert’s article here.

What’s my take on this?

Hulbert himself is keenly aware that Schannep’s Dow Theory requires the S&P 500 to “join the parade” so that a primary bear (or bull) market signal is flashed.  Since the S&P 500 has hitherto refused to confirm no primary bear market has been signaled according to Schannep’s Dow Theory

The Transports and Industrials may signal a primary bear market on their own, provided that under “Rhea/classical” Dow Theory a secondary reaction lasting at least three weeks exists, and thereafter the +3% rally on at least one index followed. This was not the case on January 30.

Therefore, in order for the Industrials and Transports to flash a primary bear (bull) market signal with the S&P500 not confirming, the whole set up had to correspond with that of the classical/Rhea Dow Theory (the "original" one, as Schannep puts it on page 99 of his book). In other words, the secondary reaction leading to the bear (bull) market signal has to be appraised according to the Rhea/Classical Dow theory. And while Schannep has unearthed quotes of Hamilton and even Rhea where they refer to a shorter time frame (less than three weeks), Schannep during his book makes clear that most “classical” Dow Theorists stick to the three-week minimum timeframe (which is true, as Richard Russell, of the "DowTheoryLetters.com" would never declare a secondary reaction with less than three weeks time; and I have read most of Russell’s newsletters since the late ninety fifties).

Thus, we cannot mix apples with pears. If we appraise secondary reactions as per Schannep’s rules, then the S&P 500 must be present for a signal to be given. Under Schannep’s Dow Theory the S&P 500 is the preeminent index, and must be always present for a signal to be flashed. Thus, Schannep requires the following combination for a signal to be given:

S&P 500 + (Industrials and/or Transports)

   

This does not mean that the “original” “classical/Rhea” Dow Theory is to be discarded. If a signal is given by the “original” Dow Theory, this signal is to be taken. In most instances (according to Schannep’s book 42 out of 44) Schannep’s Dow Theory is more reactive and flashes a signal in advance of the “original” one.

Furthermore, here I have reported that Schannep’s Dow Theory tends to be more responsive than the “Rhea/classical” one.

The bottom line is clear: if we want to play by the “original” “Rhea/classical” Dow Theory, then we have to stick to it to the fullest extent (three weeks declining prices and demanding a retracement of the preceding primary bull market swing of 1/3 or more). What we cannot do is to appraise secondaries with Schannep’s rules and, at the same time, be “classical” by ignoring the S&P 500.

All the foregoing are not mere musings. They have been confirmed very recently by Jack Schannep to this blogger truly yours.  So, if you want to apply Schannep’s Dow Theory, you better take into account the S&P 500.

One thing is clear: Taking decisions on "real time" is much harder than when looking at a chart ex post facto. I myself had my qualms.

Why the S&P 500 must always be present under Schannep’s Dow Theory?

First reason: Schannep’s book defines “bull” and “bear” markets as a +19% advance or -16% on both the Dow Jones (I guess “Industrials”) and the SP500. So when looking for “confirmation” in order to reach the +19/-16% threshold, Schannep clearly includes the SP500. It must be “in” to confirm.

Second reason: Furthermore, since Schannep’s Dow Theory declares the existence of secondary reactions much earlier than the traditional one, I find it makes sense to “tame” the enhanced responsiveness by demanding that the SP500 must always be present. In other words, if we just demand the INDU and the TRAN and at the same time we declare secondary reactions that don’t exist under traditional Dow Theory, we risk flashing too many bear market signals (as would have happened last Friday, January 30). This is especially true when we are dealing with shallow secondary reactions (i.e. barely more than 5%) which makes it even more probable to violate the lows due to mere noise.  Schannep made clear in his book that the SP500 is the paramount index nowadays, and hence it should not be easily disposed with.

Third reason: the SP500 with 500 stocks (even though unevenly weighted) is less likely to “overreact” than the Industrials or Transports which contain fewer stocks. In other words, I feel the SP500 is more representative of the broad market and less prone to whipsaws.

Fourth reason:  Page 77 of Rhea’s book still reverberates in my mind: The lows of the last completed secondary reaction are (at least “usually”) a valid primary bear market signal. We should never overlook such lows, which pertain to the “classical Dow Theory” and “generally” are a valid alternative primary bear/bull market signal. Furthermore, I am reading a classic “Profits in the stock market” by Gartley, and while I feel in saver hands by just following the Dow Theory and forgetting cycles, etc., he makes clear that the last secondary reaction lows, with or without Dow Theory tend to signal a change of trend. Thus, in many market junctures (such as ours right now) the lows of the last completed secondary reaction (in this case, the one of December 2015) are not to be forgotten. All in all: we don’t have the abyss below if we demand the SP500 to be present for the current primary bear market signal to be given (under Schannep’s DT). While I don’t have the final answer (and maybe it does not exist, as there is room for interpretation), it could well be that the violation of the last completed secondary reaction lows (even without the SP500, just by the INDU and TRANS) could also signal (under traditional Dow Theory) a change of trend (Rhea, page 77), or, at least, could be a warning to sell down a little bit. I plan to write a little bit about this in the blog (if time allows), as I feel it is important.

So, we will continue to observe the market. If the S&P 500 violated the last recorded secondary reaction lows (horizontal read line on the right of the chart), then will be a primary bear market signal be given. In the meantime, we wait.

No primary bear maket yet...or never. Stay the course.

Sincerely,

The Dow Theorist

Dow Theory Special Issue: Schannep and I brainstorming about the last Dow Theory signal (V and final)

As you know I have been writing about the last DowTheory signal in four posts.

The essence of those posts was analyzing the friendly discrepancy between Dow Theorist Schannep (of “thedowtheory.com”) and I when evaluating what for me constituted a primary bear market signal. Schannep was of the opinion that no primary bear market signal had been signaled.

The friendly discussion that followed is important for several reasons:

1)     It is a privilege to have the best Dow Theorist alive in order to discuss with him practical issues pertaining to the application in real time of the Dow Theory. Alas, we cannot do this with Rhea anymore. So I am very fortunate, and so are readers of this Dow Theory blog by implication.

2)     As Rhea wrote, the closing chapter of the Dow Theory has to be written yet. The more market experience we gain, the more useful it becomes. So many aspects of the Dow Theory are susceptible of being further clarified with the passing of time.

3)     Schannep’s Dow Theory, while being very close to Rhea’s, has some quirks of its own, which may result in interpreting some of Rhea’s rules (like my last market call) in a different fashion. More about this at the end of this post and in a future post.

4)     The brainstorming between Schannep and I prompted me to further cogitate the nuances that differentiate Rhea’s Dow Theory and Schannep’s. The result is threefold: (a) I have gained even more confidence in the absolute superiority of the Dow Theory (be it Rhea’s or Schannep); (b) I am further reassured of Schannep’s superiority over Rhea (which is not Rhea’s fault, as Rhea was writing in the nineties thirties without the benefit of many years of market action), (c) I have gained many insights about how the pros and cons of differing from Schannep when it comes to interpreting the Dow Theory.

You can find the hitherto four 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

and here:

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

So, let’s get started with this closing chapter.

Let’s recap the origin of our friendly discrepancy.

On October 10, 2014, the Industrials, Transports and SPY broke below the closing lows of the last completed secondary reaction. See chart below. So, even though, stocks were undergoing a new secondary reaction, no setup for a “classical” primary bear market signal had occurred yet, as the then ongoing decline had not been interrupted by a +3% rally. As I documented in my post, according to Rhea, there is an “alternative” primary bear market signal, namely the closing lows of the last secondary reaction (that is the preceding one, the last completed one).

Even though, Rhea wrote that there are exceptions to the rule (so a judgment call must be made on each specific instance), I saw no grounds to make an exception, as, on a general basis, exceptions are to be interpreted restrictively.

If you are really intend in grasping the subleties of this post, I encourage you to read all the posts whose hyperlinks have been given above. My best efforts are no subsitute for your own toil. Your reward will be inmense as all the things that are being written on this Dow Theory blog cannot be found in any investment book.

Lows of last completed secondary reaction (left orange) followed by red horizontal line were violated

Schannep, while acknowledging Rhea’s alternative signal (the lows of the last, completed, secondary reaction) said that he preferred in this specific instance to derogate from the rule.

One of the reasons he gave, was that stocks had recently made higher confirmed closing highs, which, as per Rhea, is a bullish indication. However, higher highs, while bullish per se do not negate Rhea’s alternative primary bear market rule: violation of the lows of the last completed secondary reaction. Thus, higher highs merely helped Schannep to make a judgment call and apply the exception to the rule.

From reading Schannep’s monthly newsletters, I think that some factors not pertaining to the Dow Theory helped him tilt his judgment in the direction of ignoring the lows of the last completed secondary reaction. Please mind that what follows is just my "feeling" and does not necessarily represent Schannep's opinion.

Which external factors did Schannep use in order to ignore Rhea’s rule and apply the exception thereto?

Well, in past newsletters, Schannep has established by different methods some price targets (which have not been reached yet, but we are getting close). Schannep is very aware that price targets, no matter how intelligently calculated, are no substitute for price action and hence he is willing to reverse his bullish stance if the Dow Theory and his timing indicator tell him that the trend has changed.

However, his price targets, served him to interpret Rhea’s rule (the lows of the last secondary reaction) in a restrictive manner and hence, apply the exception (allowed by Rhea) to the very rule, which implies disregarding the violation of the lows of the last completed secondary reaction.

I've written that Rhea’s Dow Theory is mostly ruled based. However, the specific rule which says that an alternative way of signaling a primary bear market is by violating the lowest points encountered during the last major secondary reaction of the market, is subject to exceptions, as Rhea himself wrote that “occasional exceptions can be found”.

How to decide when to apply the “occasional exception”? Well, Schannep has a very clear view of likely price targets, and in October 2014 such targets were not reached yet. Thus, I feel that Schannep decided to ignore the alternative primary bear market signal. He had the right to do so, as Rhea himself allowed for “occasional” exceptions.

Furthermore, Schannep is bullish on the economy based on leading indicators. I know this is “fundamentally-based” thinking, but such fundamentally-based thinking may be useful when deciding whether or not to apply the “occasional exception."

Successful investing is an art. The Dow Theory is the best toolset we can use to determine the primary trend. I am convinced that even a mediocre investor, not being gifted with market instincts, can be a reasonably successful investor by merely letting the Dow Theory rules soak in and applying them with discipline.

However, we must bear in mind that the best Dow Theorists have an innate talent to discern the proper time to “modulate” or make exceptions to the rule. What puts Rhea (and I feel history will judge Schannep in a similar way) in a different league, is their ability to detect the times for “occasional” exceptions.

Having read most of Schannep’s work I know this is not the first time he makes an educated guess and departs from (or at least questions) a strict application of the rules. Subscribers to his service should re-read his November 2007 newsletter. Its name says it all “a real dichotomy”. In real time, when confronted with a difficult market juncture, Schannep shows that he is not an automaton.

As to me, the following reasons (which may be wrong) prevented me from applying the “ocassional exception”:

1)     I am not so bullish on the economy. I see many, many clouds on the horizon (or rather, I’d say that we are already surrounded by clouds).

2)     While I acknowledge Schannep’s ingenuity when it comes to calculating targets for the current cyclical bull market, I am very skeptical as to any price objective. I believe (and Schannep is aware of it) what Rhea said: “neither the duration nor the extent” of a price move can be known in advance. I always say that I prefer sheer market action to guide me (rather than consideration of being the bull/bear market old or over extended according to historical standards). Why? Because the underlying fundamentals change. What if this time the US goes into high inflation? Wouldn’t this bull market last longer? Wouldn’t price targets be exceeded? What if deflation holds the upper hand? Wouldn’t such price targets never be attained?

3)     The violation of the last “significant” lows is a major tenet for good technicians in order to declare a change of trend. I am reading a master piece written in 1935 “Profits in the Stock Market” by H.M. Gartley. The author was keenly aware of the significance of such lows. So it is not just a casual observation made by Rhea.

Rhea’s alternative primary bear market rule was one of the first hidden treasuries I found when reading Rhea. I have always been deeply aware of it, and, hence in order to disregard it (even though the very Rhea allows it) I should have very powerful reasons which in this case were absent. What would be those powerful reasons?

a) A secular bull market behind. I may be wrong but valuations do not warrant tailwind. For the sake of disclosure I must say that Schannep is convinced (based on technical reasons) that we are in the midst of a secular bull market. He made this clear in his January 31, 2015 newsletter (which is a real tour de force).

b) The cyclical bull market is not old (yes, I know, I am resorting to past statistical record).

c) The economy looks brilliant.

d) No drums of war. 

Alas, I see nothing of the above (maybe, after reading Schannep's January newsletter, a secular bull market, if we are to judge on a pure technical basis, since valuations impair a secular bull market and represent headwind for it. Furthermore, the action of broad indices do not warrant optimism and my short term trading has adjusted for "weak" upthrust. My daily trading of the markets tells me there is less underlying strength or thrust than one year ago). 

Furthermore, even under this scenario I’d be uncomfortable ignoring the signal. What if a big decline is around the corner? My trader background betrays me: In doubt, get out.

Nonetheless, each investor has a different risk tolerance (for psychological and liquidity reasons). Thus, for some investors, it may be proper to cut losses short, even too short, as I did; for others, with more risk tolerance, it may be proper to accept the risk of a somewhat greater loss in exchange for more return (as some whipsaws are avoided). Personal circumstances also influence the judgment call to be made when we are confronted with a difficult market juncture.

I leave for a future post something which may intrigue you.

After reading this post you may think that it will be very difficult for me in the future to ignore Rhea’s alternative primary bear market rule (lows of the last completed secondary reaction). Not so. After almost three months of pondering and comparing Rhea and Schannep, I have reached the following astounding conclusion:

When applying Schannep’s rules, and under strict technical ruled-based considerations, it may be sensible to ignore the lows of the last completed secondary reaction more frequently than the “occasional exception” advocated by Rhea. I am not saying to ignore the rule, but the amplitude of such a last completed secondary reaction (which under Schannep's Dow Theory tends to be of lesser magnitude than those appraised as per the Rhea/classical Dow Theory) will help us decide (among other factors) whether to apply it or ignore it.

The development of this conclusion will be made in a future post of this Dow Theory blog.

Sincerely,

The Dow Theorist

Dow Theory Update for February 2: No primary bear market signaled yet, as the SPY refuses to confirm

Trends for gold, silver and their miners unchanged.

US STOCKS

The SPY, Industrials and Transports closed up. On Thursday, January 29, the Industrials violated their secondary reaction lows (which puts us very near to a primary bear market signal). On Friday 30, the Transports did so. However, lack of confirmation as the SPY has refused to violate its secondary reaction lows) prevent us from declaring a primary bear market. Today’s action has, for the time being, eloigned such a peril. So we have to further observe the market. Please bear in mind that under Schannep's Dow Theory the S&P 500 (SPY) must be present for a valid primary bull/bear market signal to be given (However, just the Industrials and Transports suffice, if we had had a secondary reaction as per classical/Rhea Dow Theory)

Stocks set up for a primary bear market signal on January 23^rd, as explained here.

The primary trend remains bullish, as explained here and here.

The secondary trend is bearish as explained here.

Readers of this Dow Theory blog, stay tuned: I plan to post very shortly (maybe later today or tomorrow) the closing chapter of the saga “Schannep and I brainstorming about the last Dow Theory signal”. It has been a real tour de force, and I thank Jack Schannep of “thedowtheory.com” for sharing insights with me. For me such insights are valuable, as they are not to be found in any book.

Gold and Silver

SLV and GLD closed down. The primary trend is bullish as explained here. The secondary trend is bullish too (no secondary reaction in sight). So in spite of today’s action, not even the secondary trend has been changed if we are to look at the markets through Dow Theory lens.

Gold and Silver miners ETFs (GDX and SIL)

As to the gold and silver miners ETFs, SIL closed and GDX closed up.

On January 12, 2015, a primary bull market was signaled. More information as to the details of such a signal here.

The primary and secondary trend is bullish.

Sincerely,

The Dow Theorist