A reader asks:
“So...what does Dow theory indicate to you, NLO? This Dow Theorist thinks we have experienced capitulation, and it could be smoother going forward.”
Our response:
Step 1: We will review the work as presented by Jack Schannep.
“…a short-term oscillator which measures the percent of divergence between the three major stock market indices (DJIA, S&P500, and the NYSE Composite), and their time-weighted moving averages. When all three indices are simultaneously in double digits below those respective moving averages, we have Capitulation. The most recent occurrence of Capitulation is shown below. The 16 dates, market levels, and the subsequent returns over various timeframes are shown below. You’ll see that the end of the last 9 bear markets were signaled, and 3 of the 7 before that. Some bear markets end, however, with a whimper, hence no Capitulation indication.”
Step 2: We address some house cleaning issues.
First and foremost, the above Capitulation Indicator is not Dow Theory. This is not a problem as the data should speak volumes, as it does in this case.
Second, the S&P 500 index did not exist until 1957. The merging of Standard Statistical Company and Poor’s, creating Standard & Poor’s, did not occur until 1941.
For this reason, the claimed data from 1953 to 1957 is based on reconstituting of the index based on stocks that would have mimicked the Dow Jones Industrial Average or the New York Stock Exchange Composite.
Using the S&P 500 data from 1957 arrives at only 37% of available data that can be found for the Dow Jones Industrial Average.
Step 3: The data: Initial Thoughts
In the Capitulation Indicator above, we like to eliminate indications that occur within a year of the last indication. Why? Because it artificially increases the outcome. Additionally, it puts into question the decision of whether to use the indicator the second time if the market was lower than the initial date. This would have resulted in the elimination of the following dates:
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September 30, 1974
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December 3, 1987
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July 19, 2002
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October 9, 2002
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November 12, 2008
These dates would have been considered false signals, in our view, comprising 33% of the averaged data.
This brings us to the dates that are suggested. Did the S&P 500 decline below the level that the Capitulation Indicator suggested? Yes, on several occasions, the S&P 500 declined below the prior signal. Does the mean that the indicator is unprofitable? No. However, when the closing commentary on the data is “…Some bear markets end, however, with a whimper, hence no Capitulation indication” and only a third of the data is covered, we cannot make a fair assessment of the qualitative elements of the Capitulation Indicator.
Conclusion:
All we can say is that some refinements are needed based on what we have seen so far. Regarding Dow Theory and potential downside & upside targets, the subscriber links below outline in detail our take on the topic.