Dow Theory Update for January 23: How a Falling ERP Isn't the Bearish Sign You Thought It Was

Dispelling another investment myth

Is a falling Equity/Risk Premium (ERP) bearish for stocks? No, it isn’t. Jay Kaeppel (HERE) debunks another investment fallacy by showing that a falling ERP does not influence the stock market. So, a relatively low yield of stocks vs. bonds has zero predictive power of future performance. Actually, as shown in the screenshot below, the stock market is up an average 9.57% after the ERP crossed below 0.5 (which means stocks "expensive" relative to bonds). 

In trend following, our trade horizon seldom exceeds a year, making most fundamental measures, especially the equity risk premium, counterproductive to our performance. Paying too much attention to them can be detrimental to our portfolios. Our Composite Indicator, which is a trend-following indicator based on the Dow Theory for the 21^st Century and the BlayTiming Indicator, made over +18% in 2023 by ignoring a persistently high ERP during 2023. 

The moral of the story: Focus on price action, and don’t let yourself be fooled by the noise.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

 

 

Dow Theory Update for January 18: Is the U.S. stock market overvalued?

 Perhaps it is, but there aren’t many alternatives left

I'm not a staunch supporter of fundamentals, but if there's one I truly endorse, it's economic freedom as a predictor of future prosperity. The freer the market, the more prosperous the nation, and its stock market mirrors this.

Therefore, it doesn't make sense to me to consider Chinese or European stock markets as bargains just because the U.S.A. may be overvalued. It might be, and it may correct. However, fundamentally, I prefer aligning my fortunes with a country that stands out as one of the cleanest shirts in the laundry basket despite not being flawless in terms of economic freedom. Cheap is cheap for a good reason. Can a country with centralized command ever surpass the U.S.A.? I highly doubt it unless the U.S.A. becomes less free someday.

The charts below showing the performance of the S&P500 vs. the Chinese large-cap ETFs tell the whole story. 

 

Finally, never forget that valuations have zero predictive power of the stock market performance one year ahead, and, as market timers our time horizon for a trade rarely exceeds one year. So, high valuations for the U.S. stock market are not an excuse for trying to catch falling knives around the unfree world under the misguided assumption that they are “cheap”. Don’t forget that trends tend to persist, and “cheap” will probably become “cheaper”.  

Sincerely,

Manuel Blay

Editor of thedowtheory.com

Dow Theory Update for January 13: Use and misuse of the Dow Theory

 Not everything touted as Dow Theory is the real thing.

No technical analysis system is more abused than the Dow Theory. Some individuals peddle their eccentric notions under its banner to profit from its respectable track record, misrepresenting them as Dow Theory to make a catchy headline. A recent case involves the confusion between the "Dogs of the Dow" and the "Dogs of the Dow Theory." It's important to note that the former is a dividend-focused stock-picking strategy within the Dow 30, unrelated to the principles of trend following or Dow Theory. The "Dogs of the Dow Theory" does not exist. The screenshot below is from Google Alerts:

 

The Dow Theory has nothing to do with “dogs” or “cats.”

Sincerely,

Manuel Blay

Editor of thedowtheory.com