Category Archives: Dow Theory

Dow Theory: August 2, 2011

Posted on August 2, 2011 by | 3 comments
In a first since the bear market bottom of March 9, 2009 and the bull market indication that initiated the New Low Observer on July 24, 2009, the Dow Jones Industrial Average and the Dow Jones Transportation Average has signaled the beginning of a bear market.

 

The last confirmation of the bull market that we received was on April 6, 2011. At that time we suggested that the market, as a leading indicator for the economy would continue to rise for “…at least for the next month and a half….” As far as the market is concerned, the top came in early May.

 

Almost as a total shock to some, the announcement of the extension of the debt ceiling didn't help the market in the least. In fact, one could have applied the adage “buy the rumor (of a deal), and sell the news.”

 

Today, the Dow indexes continued to slump and ended the day down more than 2%. While we would look for a breach of the June 2011 low to be a key indicator of the bearish trend, we’re primarily focused on the March 2011 low to be the most revealing level. The charts below graphically make clear what may become the trend for the market over the next several months.

 

Starting back in May 2011, both indices had risen to the high then retraced (secondary reaction) in June before heading higher. The Transports took off and broke above the May high hitting 5,618 (point A1). The Industrial, however, failed to confirm by going to a new high and reached only 12,724 (point A2). This first non-confirmation was a definite sign of bearishness, although it did not signal a bear market had begun.

 

As our April 6, 2011 Dow Theory article indicated, “What we see from the Transports on the way up we may also see on the way down.” Today was no exception to that idea. The Transports didn’t bother falling to the prior secondary reaction levels set in June, instead it plummeted past the March 2011 low. Both the Industrials and the Transports closed the day lower than such key support as noted in point B. The Industrials closed slightly below at 11,866 (point B1) while the Transports tumbled to 4,942 (point B2).

 

What is most worrisome now is that the Transports have taken out both the June low and the March low of 4,950 as seen on the chart at point C2. The Industrial index may appear to have quite a distance to go, but our calculations reveal that it would take only 2.1% decline for the index to confirm the Transports (point C1) action. Confirmation of the March lows by the Dow Industrials would be a devastating signal for the stock market and economy going forward.

 

The characteristics of the market in the last several months is not unlike what was experienced back in November 2007 when Richard Russell wrote and excellent article on the bearish Dow Theory implications for Barron's (article here). The similarities between now and 2007 don’t end there. The charts of the Industrial Production Index (INDPRO) show a pattern of trying to achieve new highs in 2007 and the present but then failing.

 

The connection between the Industrial Production Index and Dow Theory is well established as put forth by the Dow Theorist Robert Rhea. Our last article (found here ) on the Industrial Production Index made clear the importance of considering the movements of this indicator.

We’d be jumping to conclusions if we went so far as to conclude that the July Industrial Production Index numbers would not exceed the March 2011 high of 93.0943. However, we would be surprised if the INDPRO, despite already being so close to the high, manages to go above the numbers that were set in June and March 2011.

The caveat to our analysis on the Dow Industrials and Dow Transports is the possibility that the Industrials actually don’t go below the low set in March 2011 (considered a divergence or non-confirmation of the trend). If the Dow Industrials do not confirm the same lows as the Transports then we’d essentially be in a Dow Theory no-man’s land. Under such conditions, the bias should be towards being bearish but on a wait and see basis.

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Posted in bear market, Dow Theory

Dow Theory: Waiting for Confirmation

Posted on June 30, 2011 by | Leave a comment
Recent activity in the Dow Jones Industrial Average (DJIA) has given favorable indications that we may reach a confirmation of the bullish trend that has been established since July 2009. Below is a chart of the DJIA for the last six months.
On the DJIA chart are several characteristics worth noting. First, and what we believe to be the most important, is the ability for the DJIA to break above the fair value level (yellow line). The fair value level, also referred as the 50% principal, indicates where a majority of investors in the index of stocks are at a break-even point with their investment.

Next is the unconfirmed bull market indication at point A (red line). Occurring at the same time that the DJIA is above the fair value level is the fact that the index broke above point A (red line) which indicates whether or not there is any conviction in the market to go higher. For the time being, there is plenty of conviction in the market as represented in the consecutive triple digit gains that have been posted despite the worrisome foreign and domestic economic news.

There are a couple of important points to highlight about the two positives that have been mentioned. First is the often misinterpreted view by some Dow Theorists to accept that if the price of the DJIA goes above point A (red line), then we’re in a confirmed bull market. In fact, this indication, going above point A, is only telling us that the next target for the index is to the previous high (point B; green line) and the trend is bullish. The market still has the opportunity to get a non-confirmation by either the Dow Jones Transportation Average or the Dow Jones Industrial Average not advancing to a new high (point B; green line). Lack of a confirmation from either index could weigh heavily on the prospects of a market advance.

The next issue dovetails with the first. By going above the fair value plane, it could be interpreted that the market, on a short-term basis, is overvalued. Not only could the market be considered to be overvalued, we could also consider that there is a built-in upper limit for the market. Many investors could interpret the prior high (point B; green line) for the DJIA to be as much risk, in a 2-year doubling of the market, as they’re willing to accept.

Each of these concerns are at play when new information comes in that implies risk is being added to the market. The problems with Greece, US deficit and debt, municipal default, inflation in China, and nuclear threat to Japan are already factored in for the next 3-9 months. There has to be a new twist on the current themes or a black swan event, something that no one has considered, to change the current message of the market.

As a follow up to prior commentary on Dow Theory, the DJTA continues to lead the way higher. In this case, the Transports fell the most (-8.45% v. –7.11%) from the peak in May and the DJTA recovered the most (+7.18% v. +4.35%). We continue to keep a watchful eye on the Dow Jones Transportation Average for any early indications of market direction (chart below).

Our best guess is that the upside prospects are for the DJIA and DJTA to go back to their respective highs set on April 29th and May 10th. Between now and then, investors should remain focused on our Dividend and Nasdaq 100 watch lists for new opportunities with companies that are undervalued and good long-term investments.
  • This is a follow-up to our last Dow Theory market call on April 4, 2011

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Richard Russell Review: Wrong About the Industrial Production Index

Posted on June 12, 2011 by | Leave a comment
On June 6th, Richard Russell wrote an article on the Financial Sense website titled “Are We Fated to Live 1929-1930 All Over Again?” In that article, Russell discussed the Barron’s Monthly Index of Physical Volume of Industrial Production [BMIPVIP] reflecting on the movements of the index as compared to the Dow Jones Industrial Average in the period from the peak of the stock market in 1929 to the bottom in 1932.

Richard Russell pointed out that from November 1929 Barron’s Monthly Index of Physical Volume of Industrial Production [BMIPVIP] gave ample warning that the direction of the U.S. economy was still headed lower despite the rebound of the Dow Jones Industrial Average from November 1929 to April 1930 as depicted in the chart below.

Source: Persons, Warren. Barron's. May 15, 1933; pg. 18
Because the BMIPVIP was discontinued in 1938, we’ve used the closest approximation which is the Federal Reserve’s Industrial Production Index (INDPRO) found at the St. Louis Federal Reserve website.  In order to make a comparison to the two indexes, we checked the performance of the INDPRO to the BMIPVIP.  Below is the chart of the Barron’s adjusted and unadjusted BMIPVIP index and the Federal Reserve’s INDPRO from 1919 to 1933.

 It can clearly be seen that the Federal Reserve’s index (INDPRO), which is still in use today, can be used to measure against the Dow Jones Industrial Average.  Whenever the Barron’s index zigged the Fed’s index zigged, whenever the Barron’s index zagged so too did the Fed’s index.  We believe that using the Fed’s Industrial Production Index is the best and most consistent approximation to compare to 1929 to 1934 (shown below) as well as today’s market.

source: Person, Warren. Barron's. May 15, 1933. pg. 18.





According to Russell, the BMIPVIP hit its high in the month of June 1929.  This was a full 3 months before the peak in the Dow Industrials in September 1929.  The Federal Reserve index actually peak in July 1929 however, this was still ample enough time to gain inferences from the index’s movement.

Russell correctly observed that the BMIPVIP was critical in the evaluation of whether or not the economy and the stock market were on a rebound.  The great Dow Theorist Robert Rhea first introduced the use of Barron’s Industrial Production Index in his book Dow’s Theory Applied to Business and Banking.  Rhea used BMIPVIP as a means to confirm the signal provided by Dow Theory which contributed to his accurate call of a market bottom in July 1932.

Richard Russell’s point was that even though the stock market rallied strongly after the initial crash from the September 1929 high to the November 1929 low, the subsequent rebound was unsustainable when viewed from the perspective of the BMIPVIP or the INDPRO.  Unfortunately for Russell, his analysis of the BMIPVIP index and the Dow Jones Industrial Average comes to the wrong conclusion when attempting to bring actions of the past to market activity of the present.

Russell closes his article with the following thoughts:

“After April 1930, the post-crash rally ended, and a great bear market began. As the market turned down again, the US economy crumbled. By July 1930, Barron's Index of Industrial Activity had fallen to 85.5. The Great Depression was on.

“And I'm wondering about the comparison with today's action. Recently, we've seen the Dow climbing steadily from its March 2009 low, all the while with the economy neutral to weak. Then we see the Dow hitting a high last month in May with business today sluggish and even weaker than it was in January.

“And I'm wondering, ‘Are we fated to live 1929-1930 all over again?’ Is the stock market rally of March 2009 to May 2011 a repeat of the stock market rally of November 1929 to April 1930? In both instances, business weakened as the market climbed higher.

“But the scary part is that in 1930 when the Dow broke support, the Great Depression began and Barron's Business Index continued to plunge. Let's keep an eye on the March 2011 lows -- Dow......11613.30 and Transports ....4950.17.”

We’re disappointed that Russell’s remarks are uninformed and misleading with the intent of creating fear. First, Russell withholds the data necessary to test whether his assessment is accurate. Next, Russell implies that the Dow Industrials of today may be rising in spite of the Industrial Production Index falling. However, the Fed’s INDPRO has been in perfect alignment with the rise of the Industrial Average since 2007 as shown in the chart below.

Finally, Russell closes his article with an attempt at drawing the events of the past to the present.  Russell's effort lacks all substance when he speaks of targets for the Dow Industrials to watch for but doesn't introduce the Industrial Production Index nor it's relationship to 1929 and today. 

While the true test may come when the Dow Industrials and Industrial Production Index (INDPRO) attempt to exceed the prior high of 2007, there is little indication that Russell’s assessment is correct.

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Posted in Barron's, Dow Theory, Industrial Production Index, Richard Russell, Richard Russell Review

iShares Silver Trust (SLV) Debrief

Posted on May 5, 2011 by | Leave a comment
On April 14, 2011, we provided what we believed to be the downside target for the Philadelphia Gold and Silver Index (XAU) in anticipation of the current decline that is taking place using Edson Gould’s speed resistance lines (article here).  Although appearing to be very similar, there is a distinct difference between Gould’s resistance lines and Charles Dow’s 1/3 support levels.  Gould’s lines have support levels based on 1/3 of high while Dow’s support levels are based on 1/3 the difference between the prior bottom and the most recent high.

 

In this review we’re going to tackle the trading pattern of the very controversial iShares Silver Trust (SLV). In the chart below we have drawn the Dow Theory support levels where the price of iShares Silver Trust (SLV) is likely to revert to as part of a normal reaction.  As a point of clarification, according to Dow Theory, a bear market does not begin until the index or stock falls by at least 1/3 of the prior rise.  In the case of (SLV), today’s closing price at $33.72 heralds what is sufficiently below the first support $34.52 and should be considered to be a bear market. 

 

Although this could be considered a bear market based on Dow Theory, we only need to look back to 2008 to know how quickly and viciously a bear market in precious metals can begin and end.  The precious metals bear market of 2008 crushed the XAU gold and silver stock index with a 68% decline in eight months.  During the same time, the iShares Silver Trust (SLV) declined slightly more that 55%.  

 

Bear market or not, some observations are worth considering.  First, in the chart below, the overall pattern of the price decline in (SLV) for the Dow Theory indication numbered 1 (in green) is very similar to the current decline represented with the Dow Theory indication numbered 2 (in blue).  Since Dow Theory works on a relative basis, once initiated at a major low, the signals provided are not confused through the distortions of large or small numbers.  Headlines about SLV having declines of historic proportions are grossly exaggerated if there is no comparison on a percentage basis and compared to prior declines.

Second, at the beginning of each run at point 1 and 2, the price of SLV bounced off of the middle line B (also known as the 2/3 support line) before going parabolic. 

Finally, the decline from each peak was rapid and vicious.  One-third of the prior rise was wiped out in a matter of days after the peak.

 

 

What remains is a high level of uncertainty for (SLV) going forward.  However, in general, we should see SLV tread water for a brief period of time before falling back to the prior low which began with the current run back in November 2008.   Dow Theory suggests that a reasonable buying opportunity would exist at below line B (blue line B).  However, we wouldn’t jump in at the slightest move below line B.  Instead, we’d like to see the price decline to the dashed blue line at $15.41 or below.

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Posted in Dow Theory, Edson Gould, gold, iShares Silver Trust, Silver, SLV, XAU

Price Decline Equals Dividends Canceled

Posted on May 4, 2011 by | 1 comment

The question of retaining profits on quality dividend companies through the selling of a position seems to counter the whole point of dividend investing. After all, aren’t you supposed to allow the dividends to compound? In a small way, we described one approach and our rational for selling quality companies after small gains in yesterday’s article (Our Primary Concern: Retaining Profits).

However, there is another way to view the rationale behind selling a dividend stock after a “fair profit.”  In the early years of the Dow Theory Letters, Richard Russell would often cite a Robert Rhea quote about the impact of a stock decline.  Rhea said: 

“’Buying in bear markets is merely gambling and not very good gambling at that. Why not have cash instead of investments in bear markets? Why insist that one cannot afford to forego investment income when one day’s price shrinkage may cancel several years’ dividends?’”
Russell, Richard. Dow Theory Letter. May 10, 1960. Issue 103. page 2. www.dowtheoryletters.com.
The idea of canceling several years of dividends is at the forefront of our thinking when gains evaporate into losses.  In Richard Russell’s Dow Theory Letter dated November 23, 1960, he presents, in literal terms, the impact of price decline and the loss of years of dividend income in the process.  The table below is from Russell’s newsletter and needs little in the way of explanation.
Source: Richard Russell, Dow Theory Letters, http://www.dowtheoryletters.com/

Because stocks are not required to return principal with a stated yield as with many bonds, there is no assurance that the price will recover to the level that a purchase was initiated. Therefore, receiving short-term income on a dividend stock, although a necessary source of income for retired individuals, the prospect exists that an investor could end up with only a portion of the principal instead of the intended income plus principal.

The lack of assurance of principal and income with dividend stocks is why we believe people have become disenfranchised with technology stocks like Microsoft (MSFT) and Cisco Systems (CSCO).  If they’ve invested in the stocks with the belief that they’re in it forever, when the decline comes, absent any dividend, there is little recourse or hope of recovering lost funds or keeping up with inflation.

Even new investors to Microsoft and Cisco Systems, aware of their bold promises in 1999 and subsequent failure to deliver in 2011, are asking themselves, “is it really worth facing the prospect of no return?”  These questions are being asked when in some instances, especially with Microsoft, the timing probably couldn’t be better (especially now that they’re paying a dividend).  Our supplementary comments on Microsoft can be found here.

While we subscribe to the Graham/Buffett principles of investing (buying for the long-term, you’re buying a business, concentrate on values, etc.) we assume that since there are only a handful of billionaires hewn strictly from investing in stocks, we might do well to hedge our thinking and strategy.

Finally, further analysis of Robert Rhea’s claim on not being invested at all during bear markets is something that is at odds with Charles Dow and we’ve decided is not appropriate or necessary.  From our experience, bear markets are no guarantee of losses in your portfolio.  Charles H. Dow, founder of the Wall Street Journal, has said that:

"Even in a bear market, this method of trading will usually be found safe, although the profits taken should be less because of the liability of weak spots breaking out and checking the general rise."

Schultz, Harry D., A Treasury of Wall Street Wisdom, Investors' Press, (New Jersey, 1966). p. 12. Additional commentary here.

Evidence of the fact that bear markets don’t always equal destruction of wealth, while going long stocks, is demonstrated in our 2007, 2008 and 2009 performance review.  Naturally, 2008 is not expected to be replicated (having gains, while going long only, during a market decline of 40% or more).  However, we do know that being all in or timing the market to be all out during bear markets shouldn’t be the goal.  The goal, from our perspective, should be the preservation of gains whenever possible.

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Posted in CSCO, Dow Theory, Harry Schultz, MSFT, Richard Russell, Robert Rhea

Richard Russell’s Miscue

Posted on April 6, 2011 by | Leave a comment
On the Dow Theory Letters (http://www.dowtheoryletters.com/) site yesterday, there was an interesting admission by Richard Russell. Russell said:
“I mistakenly took the vicious decline of 2007 to 2009 as a turn in the tide and a bear market.”
This comes as a shock since most market veterans would say that when almost every market, foreign and domestic, declines by 30% or more then it would be sufficient to label it as a bear market. When the gold stock index (XAU) declines 62% along with almost all other commodity indexes then a reasonable person, lacking any other term for it, would call that a bear market.
Instead of being a bear market, according to Russell, the decline from 2007 to 2009 was simply a “…correction in an ongoing bull market.” As I attempted to process this thought, I only wonder what Russell would re-characterize the stock market decline in Japan (from the 38,000 to 8,000 level) as. Dow theorists like Hamilton, Rhea and many others are very clear on what constitutes a bear market. Russell’s assertion that 2007 to 2009 was simply a “correction” was in complete contradiction to his prescient call of an eminent bear market in Barron’s in November 2007. Nor does Russell’s latest missive add credibility to his prior claims that the rise in the market from the 2003 low was a bear market rally.
To top off Richard Russell’s wild claim that a year and a half decline of over 40% in global equity price was only a “correction” is the fact that he omitted any reference to Dow Theory having any role in his sudden realization that he was wrong about his belief that we were only in a correction rather than a bear market. Russell credited his not so secret Primary Trend Indicator, Lowry’s Selling Pressure Index and Lowry’s Buying Power Index. Apparently, Dow Theory plays a small or non-existent role in a publication that is titled The Dow Theory Letters.
By inference, not crediting Dow Theory for his change in thinking suggests that Dow Theory doesn’t work. However, the NLO team has been adamant that up to this point, Dow Theory has indicated that we’re in a bull market and that a bear market has not been signaled since the July 23, 2009 bull market indication. This is in stark contrast to Russell’s back and forth calls of a bull and bear market as early as January 2009.
So what is Russell’s remedy for his error in judgment for the last 2 years? In today’s note (April 6, 2011) Russell says, “If this market is going to turn primary bearish, I would want to see an orthodox Dow Theory bear signal.” Wait a minute, as the market was rising Russell arbitrarily misapplied his version of Dow Theory and now he thinks that he’ll turn bearish when he receives “…an orthodox Dow Theory bear signal.”
As an attempt to salvage some sort of credibility Russell says, “In the meantime, all is not lost. Gold is at new highs as are the gold ETFs, and silver is at a 31-year high.” This comes after Russell said on March 1, 2011 that if the Dow Industrials fall below 11,800 then investors should sell all stocks “including gold stocks." Well, on March 16, 2011, the Dow fell to 11,600 leaving anyone who believed Russell’s commentary on March 1, 2011 in the lurch.
The NLO team is disappointed since Richard Russell has been the primary inspiration for our work in Dow Theory and critically analyzing financial markets. In addition, we’d rather have Russell retire as a legend with a legacy that will continue to inspire. However, Russell’s latest work comes off as sloppy and requires significant willingness to view his work as entertainment, at best.
 
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Dow Theory: Cyclical Bull Market Confirmed

Posted on April 6, 2011 by | Leave a comment
On April 4, 2011, we were provided with a Dow Theory confirmation of the cyclical bull market, within a secular bear market, when the Dow Jones Industrial Average exceeded the prior peak of 12,391.25 set on February 18, 2011.
As has been the case throughout this bull market run, the Transportation Average has taken the lead on the way up. This most recent move by the Industrial Average only confirms what the Dow Jones Transportation Average managed to accomplish on March 31, 2011 by closing at 5,299.89. At least for the next month and a half, the economy is expected to continue to grow. What we see from the Transports on the way up we may also see on the way down.

What do the new short-term highs mean for the market overall? It appears to indicate that the Dow Industrials will continue to stagger towards the old high that was established October 9, 2007 at 14,164. For us, a possible leading indicator for the market (even before the Transports) is the price of gold and silver. If precious metals can continue to rise then the Dow has a more favorable chance of rising. However, if precious metals are falling then, in this stage of the interest rate cycle, the general market will have little chance of going up.

According to Dow Theory, all technical indications in the stock market should translate into the economy. Dow Theory was never intended to predict the stock market. Instead, Dow Theory was intended to determine if the prospects for the economy were favorable or not, using the stock market as a leading indicator. The best example of this is in Robert Rhea’s easy to read book, The Dow Theory Applied to Business and Banking.

 
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Dow Theory: Continuation of Bull Market Confirmed

Posted on February 14, 2011 by | Leave a comment
On Friday February 11, 2011, The Dow Jones Industrial Average (DIA) and the Dow Jones Transportation Average (IYT) registered Dow Theory bull market confirmations. This confirmation is a continuation of the first bull market indication that was given on July 23, 2009.

The majority of the Dow Theory bull market confirmations since July 2009 has hinged on the movement of the Transportation Average and this most recent indication has been no exception. In accomplishing the Dow Theory confirmation of the bull market, the Transportation Average had to overcome significant technical resistance. In the chart below, you will see that the decline and recovery in the last month has been dramatic.

Over the last month, the Transportation Average has managed to succumb to an inverted head-and-shoulders pattern. This suggest that there is strength in the rise of the Industrials and Transports most recent bull market confirmation since, as the chart below demonstrates, the Industrial Average never let on that there was any weakness to the same extent that the Transports did.

In the last Dow Theory confirmation of the bull market on November 3, 2010 (article here), the Dow Industrials fell about 2% (on a closing basis) over a period of 29 days before regaining its footing and heading to the current level. From the November 3, 2010, it took 101 days for the Dow Industrials to rise 9.44% and the Dow Transports to rise 7.69%.

Looking ahead, if the markets were to replicate the prior modest moves in the same period of time then we could expect an intermediate low around March 11, 2011 with the Industrials and Transports peaking at 13,431.86 and 5638.12 on May 22, 2011, respectively. Our recent article on where the market might top (article here) indicated that June 18, 2011 is the farthest out we could project on a cycle basis. We now have refined this assessment down to between May 22nd and June 18th.

It would be exceptional if the market could accomplish the 13,000 level given the current valuation and the uninterrupted (no Dow Theory bear market indications) run we’ve had since the first Dow Theory bull market indication on July 23, 2009. Achieving 13,000 is only 6% away however, what is more important is sustaining the momentum.

Naturally, the alternative to this optimistic market forecast is that the Industrials and the Transports give a bear market signal somewhere between May 22nd and June 18th. Simultaneously falling below 9,700 for the Industrials and 3,900 on the Transports would indicated that a new bear market has begun. Until then, we can look forward to modest gains and nearly full exposure to the stock market for the next 2-4 months.

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Market Review and Analysis

Posted on January 28, 2011 by | Leave a comment
As the Dow Jones Industrial Average (DIA) approaches the 12,000 level, we believe it is necessary to review our analysis leading up to this point. There have been indications that the market would knock on the door of 12,000. And we’ve been at the forefront of this analysis very early on.
Starting as early as February 12, 2009 (article here), we warned that despite the declining trend in the markets, history has proven that declines of 40% or more tend to retrace 60% to 100% of the previous decline.
In September 2009, after reviewing the Coppock Curve (article here), we pointed out that if the market held up in October 2009 that 12,000 on the Dow would not be an unrealistic price target.
In January 2010, we mistakenly thought that the Dow had a good chance to reach 12,000 by February 2010 (article here). Although we were woefully inaccurate in the timing of our estimate, we were convinced that 12,000 as an upside target was not unreasonable.
On March 23, 2010, we came out with an article that highlighted what we thought was confirmation of a cycle low in the market on February 8th (article here). In retrospect, although it was a major low for the year 2010, it was not as significant as the July 2010 low. However, we reiterated 12,000 as the target for the Dow.
Our eyes are now trained on the next target for the market. This is where our “analysis” is put to the test. All along we’ve thought that a rise from 6,400 to 12,000 would not be very unusual. However, getting back to even, or 14,164, will be very challenging. There are many who feel that external forces have falsified the markets rise.
As far as we’re concerned, we’ve accomplished the target that was long since projected and is now upon us. As we’ve indicated in a recent article, the Dow Industrials’ upward trend has less to do with the actions of the Federal Reserve and more to do with the corrective nature of markets after a significant plunge like in the period from October 2007 to March 2009 (article here).
We’ve noted in the article titled “Diversification Doesn’t Matter” that declines in the Dow will be amplified in the S&P 500 and Nasdaq Composite Index (article here). Exposure to these diversified indexes through the use of index funds and ETFs will result in surprising losses that defy the theory of diversification as was the case in 2008.
We believe that as long as the price of gold keeps moving higher in conjunction with the Philadelphia Gold and Silver Index (XAU) and Dow Theory confirmations of the bullish trend continue, there is a good chance that the market will retrace 100% of the previous decline from 2007 to 2009. At times like these, the rise and fall of the price of gold may be a leading indicator for where the market might be headed. Our numerous articles on the correlation between gold and the stock market have proven to be correct for those willing to accept the data from an unemotional standpoint (article link).
Although it is not unusual for markets to retrace 100% of a prior decline of 40% or more, we’re more than willing to figuratively step aside and watch what happens next. However, we cannot help taking another stab at when, and not at what exact level, the Dow Industrials will peak. Two prior articles on the topic are the basis for our thoughts on the prospects for where the top may occur.
On June 14, 2010, we wrote an article titled, “A Market Cycle Worth Observing” (article here). In that article, we reminded readers of the consistency of 4-year cycles to provide key markers for tops and bottoms in the market. We included referenced from Charles H. Dow’s era, founder of the Wall Street Journal, from 1901 and prior. We gave examples as provide by Richard Russell from 1953 to 1979. We were even able to provide examples from the period between 1987 and 2009.
If there really are 4-year cycles, as we contend, then October 2007 would stand as the marker for the last peak in the cycle. In theory, the mid-point for the peak would be some point in 2009. For us, March 9, 2009 represents the low or mid-point for the 4-year cycle. Our estimate is that the full 4-year cycle should be completed with the Dow Jones Industrial Average peaking at some point in 2011.
According to Dow Theory, the downside target is set at 9,273.50. If this level is breached in conjunction with the Dow Transports, then we could consider a bear market has been initiated.
The second article that we derived our view of the market is dated April 11, 2010 on the topic of Dow Theory (located here). In that market analysis, we proposed, in addition to the fact that the Dow Industrials “…could go to 11,574.59 with no problem,” we outlined three hypothetical scenarios under which the Dow Industrials would reach 14,164.
In retrospect, and upon further analysis, we realized that those projections were really indications for when the market would top irrespective of the exact level that the top would occur. It seems to us that the period from January 31, 2011 to June 18, 2011 is the timeframe for when the completion of the cycle should take place.
Despite our concerns for an eminent top in the market, we will continue to buy and sell individual stocks. From our experience in 2008, gains can be obtained from individual stocks within the context of a declining trend in the market. In fact, during 2008 there were only three months where losses were registered which were June, October and November. Although these months incurred substantial losses, 2008 ended with overall gains of 14% in our portfolio (article link).

 

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Posted in 4 1/2 year, 4 year, Coppock Curve, Dow Theory, gold, Richard Russell

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Dow Theory Q&A

Posted on November 8, 2010 by | Leave a comment
A reader comments on a prior thought:

1. Part of the confusion might be that Mr. Schannep gave a SELL signal on 30 Jun 10 -- that articlle of yours seems to have been published that very day, while the 2nd sentence implies that it was written the previous day. Therefore, the next signal would have to be BUY, which came 27 Sep 10.

Is it possible you missed the 30 Jun 10 signal?

Also, your 7 Nov 10 article implies a "bull market indication" on 24 Jun 09 -- I'm not sure what that means, but as a historical note, Schannep gave a BUY signal on 9 Apr 09.


2. Regarding Dow Theory analysis: At its simplest, my understanding is that a market move must meet rather basic criteria for time and distance, as noted on page 18 (examples follow) of the book, with caveats.

A secondary reaction move, after a primary market high or low must be about 3% -- enough to allow ONE index to recover at least 3%; ONE index -- but not both -- may exceed the previous high or low. It must take at least two weeks to reach that point, which sets a "mark" (peak or trough). After which, when BOTH indicies exceeds their "mark", there is a Dow Theory Signal -- a change in trend, turn of the tide, etc.

So, the market picture for 2010 was:

DJI: High on 26 Apr, reaction mark on 7 Jun, bounce on 18 Jun, SELL signal on 30 Jun.

DJT: High on 3 May, reaction mark on 7 Jun, bounce on 15 Jun, SELL signal 30 Jun.

I've omitted SPX, since you folks seem to be somewhat "purist". However, I might suggest a review of the Dow Theory section of "Technical Analysis of Stock Trends (9th Edition)", page 24 in particular. As the basis for Dow's Theory is market movement, it should be reflected in -- or at least agree with -- movement in such a large index. In addition, merely because it did not exist when Dow, Nelson, Hamilton or Rhea were alive does not merit exclusion from consideration. Deliberately ignoring it, as Russell and Moroney do, may be akin to using Ptolemy to critique Copernicus.

The previous caveats mentioned are threefold:

1. Schannep rigorously defines Bull and Bear markets as a 19% rise/16% drop from low/high (those are reciprocal) on page 86. Therefore, they serve as a "trailing stop", should Dow Theory not give a signal.

2. Schannep also defines "capitulation" on page 90 (10% drop below 10 week average) as a drop significant enough to warrant shortening the two-week timeframe to one week, for a BUY signal.

3. The bounce after a reaction must occur over more than one day; thus the 27 May 10 bounce was not valid.

Hope that is helpful.

Our Response:

It is definitely possible that we could have missed the June 30 sell signal.  However, Let us try to prove that our understanding of Dow Theory is correct.

First, there is the issue of the primary trend. No primary trend stops and then re-starts only two months apart. This goes back to the issue that you’ve mentioned about the timing of a call. Such a short period of time between bull or bear market calls is a tip-off that a false signal had to have been triggered on June 30, 2010. A review of the primary trend from Rhea, Hamilton, Nelson, Russell and Schaefer is in order on that point.


Second, Dow Theory is all about confirmations. No matter which source that is used, there was not a confirmation of the decline to the same supports levels in the Transportation and Industrial Averages for the Feb. 5th and Feb. 7th. This is very significant because the exact same confirmation of both the Industrials and Transports was used to re-issue a buy indication on November 3 by Mr. Schannep. Although it should be said that Mr. Schannep used the S&P and the Industrials which gave a “buy” only a couple days ahead of the standard Transports and Industrials signal. Was it worth the extra days advance notice? Absolutely, if you’re already out of the market. However, Hamilton, Rhea and Russell are very clear on the risk of jumping the gun on bull and bear market signals without accurate confirmation.

In our November 4th “analysis” we were specific in indicating that we chose to opt for the sure fire call instead of the earlier call on September 27th when the markets broke above the line. Again, if the call for a “buy” signal can wait 4.73% for the sure-fire confirmation of the bull market or “buy” signal then we’ll opt for the most conservative route.

The whole premise of Dow Theory is about following the steps as outlined by Nelson and further elaborated on by Hamilton and Rhea. When E. George Schaefer proposed the 50% principal, he didn’t create something that wasn’t already a part of Dow Theory. Schaefer only highlighted an aspect that others may have taken for granted or overlooked. Adding elements that didn’t exist may seem to bring the concept of Dow Theory out of the dark ages. However, there are specific aspects that Schannep has introduced that are not consistent with Dow Theory.

Third, the introduction of the S&P 500 as a valid index to track is erroneous in that it assumes that there is an advantage by introducing the index. Since the S&P 500 was created in 1957, all data prior to 1957 is modeled on a 100% correlation to the Dow Jones Industrial Average. This means that movement in the index would have mirrored the Dow industrials which is impossible now and therefore could not possibly happen before 1957. This means that all insightful examination of price movements of the S&P 500 before 1957 is useless.

There is evidence to suggest that in the period from 1929-1932, data from the Barron’s 50 index actually declined by only 78% instead of the Dow Industrials’ 89% reflecting that human judgment related to changed in the index impacted the outcome of the decline. Without the S&P 500 being in existence at the time there is no way to test this theory. We covered the topic of changes Dow Industrial Average and their impact from 1929 to 1932 in our article titled “Dow Jones’ Decline Largely Impacted by Index Changes” and “After the Crash of 1929, Recovery was Quick.”

In addition, the current beta on the movement between the Dow Industrials and S&P 500 is only occasionally at 1 or 99.9% correlated. In any instance that there isn’t a correlation it is in the favor of the Industrials. This defies logic since any index of stocks with only 30 companies should fall by a greater magnitude and rise by a greater magnitude than an index of 500 companies. If you use the Yahoo!Finance interactive charting, you will find that during almost any period since 1970, the Dow Industrials fell less than, and rose more than, the S&P 500. Although this isn’t true for every period it is true for the majority (80/20) of periods selected especially if you pick periods further out in time to the present. This means that signals gained by one index will not be the same with another index.

We’ve already shown that there is a problem with the belief that a broader index provides more accuracy and stability in the markets in our article titled “Diversification Doesn’t Matter.” In fact, we’ve done a recent update on this data and have found that the Dow Industrials have exceed the performance of the S&P 500 in the 5-year, 3-year, 1-year, and YTD categories. In addition, the 2008 performance of the Dow Industrials fell less than the S&P 500 which defies the point of having a diversified index.

The net result of sticking to an index that existed over an extended period of time is that people of today can test the validity of the claims made by Dow Theorists in the past. If we cannot test the theory on a continuous index then we would not be able to prove or disprove the accuracy of the claims. Being able to prove the claims of people in far flung eras allow for us to give credence to the facts.

Our next issue is the introduction of Edwards and McGee’s classic book Technical Analysis of Stock Trends (9th edition). The use of such a source is unfortunate since it is not the source. The source for Dow Theory is from books published by Russell, Schaefer, Greiner, Shumate, Fritz, Dow, Nelson, Hamilton, Rhea, Olmerod, Collins and Raeder. All of the aforementioned are Dow Theorists first. Although a great book, Technical Analysis of Stock Trends is not an authoritative source for considered understanding on Dow Theory even though they correctly say that "...Dow Theory is the granddaddy of all technical market studies."

Schannep’s definitions of a bull and bear market and the parameters that are set around such definitions are probably useful and profitable. However, it is probable that we’re talking about Schannep’s theory instead of Dow’s theory. I don’t mind that Schannep has his own way of accounting for bull and bear markets. However, Dow Theory is usually much more simplified than what has been proposed by Schannep.

As mentioned before, your understanding of Schannep’s work is far greater than ours. This gives you the benefit of knowing, in our opinion, one more approach on the topic than we have. We couldn’t claim to be Dow purists since we’ve only opted for the method that seems the simplest. 


We hope our response has added food for thought and thank you for your contribution to Schannep’s work. As a subscriber to Schannep’s service, you are a credit to his efforts and thank you for your time spent explaining his philosophy.


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Posted in Dow Theory, E. George Schaefer, Richard Russell, Schannep

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A Lesson in Dow Theory

Posted on November 7, 2010 by | 2 comments
In a September 20, 2010 article titled “Dow Theorist Believes Buy Signal is Imminent” on MarketWatch.com, there are views from three different well known Dow Theorists with different conclusions from each one of them. This is an instance where the author, Mark Hulbert, should at least know something about the topic on which he writes. Instead, the author clouds the picture on Dow Theory, which few people really understand or write about. Since Mark Hulbert rates the performance of stock market newsletter, he should probably stick to the performance numbers rather than muddy the interpretation on Dow Theory by writers who aren’t following the clearly defined rules of the theory.

Now it is the job of the New Low Observer team to clean up the confusion created by Mr. Mark Hulbert, on the inaccuracies of the Dow Theorists.

First, in all instances, none of the theorists mentioned (Russell, Schannep, Moroney) could possibly be interpreting Dow Theory accurately if they are somehow about to generate a “buy” signal. This would mean that prior to a buy signal there would have been a sell signal indicated. According to our work on Dow Theory, which is well documented and freely available (check here), there hasn’t been a single sell signal since the July 24, 2009 bull market indication which was selected by the New Low Observer team as the initiation date of our website. This is further evidenced by the simple fact that the Industrials and Transports have continued to climb higher since March 2009 to the present.

Not to be outdone is the great Dow Theorist Richard Russell. Mr. Russell is referred to in the article as a “traditionalist” when it comes to Dow Theory. Mr. Russell says that he cannot “…say that even a short term buy signal has been generated. That’s because the Dow Transports as of mid-day trading in New York remain about 1% below their early August high (which came in at 4,516.35).” To his credit, Mr. Russell sticks with the use of the Dow Transportation Average for an indication of a Dow Theory “buy” signal.

Unfortunately, on the very first day that the Transports exceeded the 4,516.35 level on September 28, 2010, Russell never gave any indication that a short-term buy was at hand. The very next day, still no indication of a short-term buy indication. September 30th, still no indication of a “short-term” buy signal. As the Transportation Average continued to climb to the current level of 4,923.40, Mr. Russell has made no reference to Dow Theory based on the numbers or the technicals. Instead, Mr. Russell has talked about the major premise behind Dow Theory is values. While this is true, some consideration of current market action is what Dow Theory is all about. The pattern created by the “short-term” buy signal is exactly the same one that Russell used when he called the market bottom in January of 1975. We’re not certain why he doesn’t recognize this pattern today.

Next, as a Dow Theorist of sorts (we’re not really sure), Mr. Schannep has several issues that require addressing. Among our concerns, Mr. Schannep never needed to replace the Dow Jones Transportation Average for the S&P 500 Index in order to get a Dow Theory signal. We understand the goal of Mr. Schannep in this strategy, reduce the period of time to garner a signal so that more upside is obtain. If, in fact, the goal of Mr. Schannep was to get an earlier signal by using the S&P 500, then he probably got it by three days at best.

It is important to note that if Mr. Schannep was applying anything like Dow’s theory, then he would have to wait for the last of the two indicators to confirm a signal. This means that although the S&P 500 signal came almost two weeks ahead of the Transportation index, the Industrials’ confirmation came within three days of the Transports’ confirmation. The chart below demonstrates how Mr. Schannep could have utilized the Transportation index and gotten the same signal in the same period of time.

The matter of timing the signal is a concern that plagues every Dow Theorist. However, resorting to the tactics of Mr. Schannep only undermines the point of Dow Theory as outlined by Robert Rhea in his book The Dow Theory. Instead of changing Dow’s theory into our own, in order to generate earlier signals, we have decided to use Dow’s Theory as an asset allocation tool instead. More funds in stocks that are undervalued during bull market indications and fewer funds in stocks that are undervalued during bear market indications. This way, we’re not beholden to issues of late signals requiring modifications of Dow’s theory.

The article suggested that on September 20, 2010 a buy signal was about to be registered according Jack Schennep’s website. Mr. Schannep manages to mix the usage of the Dow Industrials, Dow Transports and the S&P 500 index to garner a “Dow Theory” buy or sell signal. It appears that, according to Mr. Schannep, if you cannot get clarity from the standard indicators, the Dow Industrials and Dow Transports, then you replace any one of the two indexes with the S&P 500 index. Mr. Schannep indicates that this approach is a more modern strategy for determining Dow Theory buy and sell indications. We don’t like Mr. Schannep’s modification to the Dow Theory but if it works profitably for his subscribers then more power to him. However, it should be said that Mr. Schannep isn’t practicing Dow Theory.

Another problem we have with Mr. Schannep is that he advocates buying at a point just short of a full confirmation. A reasonable market technician would agree that if there is only 4.73% before a clear indication is given (new high), why try to capture so little with the prospect that the market could reverse direction? Instead, wait for the clear signal and decide how much you want invested in the next move. This idea is driven home in the following chart and excerpt from a 1939 series of articles in Barron’s that later became the book “Making the Dow Theory Work” by Sparta Fritz Jr. and A.M. Shumate.


“Point 9 represents the upward penetration of the minor high, with encouragement from the volume of trading. The averages are still at levels to suggest buying.

“All rules of sound practice would forbid buying at point 10. Possible losses, figured against recent lows, are unattractively large. At the same time, a bullish forecast still lacks the authority which the averages could give by bettering the old highs. If the speculator has missed the good chances that have been left behind, surely he out not buy here. It will be far wiser to wait and pay a little more, when and if the averages jump the hurdle of their former highs.

“Aside from other considerations that enter into forecasting, the market position at point 10 actually suggests to the speculator a tactical sell-out of some of his stock. Suppose it turned out that the bull market was over. Important savings could be made by sales here. The speculator can step aside, and re-enter the market at a slight concession, if the highs are bettered.

“The bull market is demonstrated to be still in progress at point 11. Stocks can be bought here, but it cannot be considered a first-class risk. It is simply the last reasonable buying level as the primary trend moves on. Stocks bought here will sometimes show a loss on the next reaction.”

Sparta Fritz Jr; Shumate A.M. “Making the Dow Theory Work.” Barron’s (September 11, 1939). page 9.
Basically, Mr. Schannep recommends buying the market at the equivalent of point 10 when he could have more certainty in the call at point 11. In our view, this isn’t a responsible approach to calling the market, let alone a mangled version of Dow Theory.

The MarketWatch.com article makes reference to Richard Moroney of the Dow Theory Forecasts newsletter. Mark Hulbert says that Mr. Moroney has an interpretation of Dow Theory that is “different than that of both Schannep and Russell, the two Dow averages must surpass their mid April highs to trigger a buy signal. Those levels, which remain some way off, are 11,205.03 for the Industrials and 4,806.01 for the Transports.” Based on his commentary, Mr. Moroney is the only one who is actually practicing Dow Theory. The numbers that Mr. Moroney indicated as being required for a Dow Theory buy signal were exactly the same numbers that the New Low Observer team was looking for as a continuation of the bull market.

Unfortunately, there is a distinction between a “buy” signal and continuation of the trend. As mentioned before, a buy indication means that a sell had to be given previously. A continuation of the trend indicates that a prior signal is being confirmed and nothing has changed. This nuance is very importance since anyone who considers buying at this point should understand that “…it cannot be considered a first-class risk…” as described by Fritz and Shumate.

The handling of such a topic as Dow Theory should not be left to chance when the material on the topic is so accessible. Unfortunately, Mark Hulbert isn’t aware of the discrepancies mentioned above. Such a lack of knowledge on Mr. Hulbert’s part only feeds the misunderstanding about Dow’s Theory. This is reflected in the comment section that follows the article where readers justifiably deride the theory and it’s practitioners.
Note:
Any and all bull market indications are within the context of a secular bear market.  The secular bear market is deem over when the Dow Industrials and Dow Transports exceed the previous highs set in 2007.  Therefore, the current market is considered to be a "bear market rally" or a cyclical bull market.
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Posted in Dow Theory, Richard Russell

Yearning for the Richard Russell of Yore

Posted on November 4, 2010 by | Leave a comment
As Dow Theorists, it is required that we read the information that is put out by Richard Russell. So it perturbed us to find that there has been nary a peep on Russell’s site about Dow Theory based on the recent movement of the Dow Jones Industrial Average and the Dow Jones Transportation Average. As noted on our site today, Dow Theory has given a reiteration of the bullish trend that has been in place since the July 2009 bull market confirmation.
In the last two days we have feverently scoured Russell’s website for any confirmation of our perspective on Dow Theory. We’ve found nothing. Even more alarming is the vague reference to Dow Theory as it pertains to value. This reference in passing was circumspect at best and puts into question any attempt to demonstrate any understanding of the topic. On November 3, 2010, Richard Russell said:

“My own opinion regarding the markets is that the test of values trumps all other considerations.”

Russell goes on to conclude that based on historical values of the market, stocks and bonds are in a bubble. After concluding that stocks and bonds are in a bubble, Russell says that he doesn’t want his subscribers to buy stocks or bonds. Finally, in his November 3, 2010 posting, Russell laments the period of 1997 to 1999 and states, to our disbelief:

“Who were those geniuses who piled into AMZN [Amazon.com] when it was selling for under five clams?”

Along with the preceding quote, Russell included only a chart of AMZN and a description on how much he buys almost everything from the Amazon.com.
We’re not so sure that Russell was pining for AMZN back in July 1, 1998 when Amazon.com was selling for $19.02 [adjusted for splits]. At that time, in his letter published on the same date, Russell said:

“Bookseller Amazon.com is priced at over 81 [ $81 unadjusted/$19.02 adjusted] now, but it won’t be making a nickel of profit for at least two years.”

 There was no indication that Amazon.com was at a value at the time.
On November 4, 2010, Russell ties the concept of Dow Theory to values. This was the first reference to Dow Theory after the bull market confirmation on November 3rd. In this excerpt, Russell gives an idea as to what exactly he looks for to determine values, namely dividend yield and P/E ratios. Then Russell goes on to say:
“In the business of investing, money is made in the buying (see Amazon study on yesterday’s site). Buy right and you’ll end up with profits. Buy wrong, and you’ll end up with tears.”
We were perplexed that Russell would connect Amazon.com with buying values at a time when, back in 1998, there were no dividends to generate a dividend yield and no earnings to generate a P/E ratio. This attempt to demonstrate the importance of values was further distorted when Russell starts discussing buying gold in the November 4th article. Russell said:
“Buy gold at the highs, buy gold on a correction, buy gold when its in a confusing consolidation, and within five years you’ll thank the day when you bought it.”
To say “Buy gold at the highs…” counters all the efforts to educate investors on the importance of values. In addition, there was no reference to the fact that Dow Theory had giving a bull market confirmation. It is troubling that Russell further tarnishes his reputation as a keen observer of markets [regardless of being right or wrong] by not addressing the validity of the signal on a theory that is the title of the newsletter.
Although we generally agree with Russell’s perspective on gold, for different reasons, we hope his subscribers aren’t being led astray by his blatant contradictions simply because he is bullish on gold at a time that the gold market happens to be moving higher.

Sources:

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Posted in Amazon.com, AMZN, Dow Theory, Richard Russell

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Dow Theory: Continuation of Bull Market Confirmed

Posted on November 4, 2010 by | Leave a comment
In our last discussion of Dow Theory on September 8, 2010, we indicated that the Dow Industrials and Dow Transports had formed a line. The line that we discussed in the September 8th article was broken through on the upside in the month of October. According to William Peter Hamilton, a line in the market could be considered as important as a market crash. We decided against a reaction on the line being broken to the upside out of concern for jumping the gun. To be conservative on the topic of Dow Theory, we opted for the sure fire signal of a continuation of the bull market trend with the markets making new highs above the April/May points.
On November 3, 2010, the Dow Industrials confirmed the Dow Transports breach of the their respective highs since the 2009 bottom. The new high came on the news that the Federal Reserve is going to fully implement quantitative easing (QE2) to further boost the economy. In addition, the new high arrived as the results of the November 2nd election were finally in. We are not surprised of the coincidence of QE2 being introduced immediately after the election results. Our last article on the topic Dow Theory on September 8, 2010 closed with the following commentary:
“Politicians vying for re-election will fight tooth-and-nail against outcomes that don’t ‘appear’ positive. With this in mind, it is possible that the only option is to the upside.”
With this confirmation, we can only guess as to where the next stop for the markets might be. However, in our February 12, 2009 article, we discussed the idea that when the stock market falls 40% or more there is the tendency to retrace 50%-100% of the prior decline. So far the Dow Industrials have retracted 61% of the previous decline from 14,164.53. With the introduction of QE2 at this point in the game, we’re likely to achieve 100% retracement of the market from the October 2007 top.
With a goal of self-preservation in mind, we have the tendency to believe that the market is always going to fall rather than head higher. This time is no different. However, the Dow Theory signal is telling us that as long as we don’t get a sudden reversal of the trend we’ve got at least another 3 to 9 months of an upward bias in the stock market and the economy. Our September 8th article said:
“the length of time that has been spent in such a range seems to indicate that we’re due for a breakdown or an explosion if the markets cross below or above the range.”
As a result of breaking above the line and the previous high, we may experience the oddity of a full-fledged financial stock panic to the upside regardless of whether it is warranted or not. Basically, this could be the final blow-off before attaining the cyclical bull market top.
Downside targets for the Dow Jones Industrial Average are:
  • 10,000
  • 9,500
  • 8,000
Because we have a natural bias against the upside prospects, we caution all investors to pay close attention to the downside targets. All new investments should be with the acceptance that the Dow Industrials could fall to the 8,000 level without warning. However, facts being what they are, Dow Theory seems to be pointing the way for the economy and the stock market.

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Posted in Dow Theory, Dow Theory Bull Market indication, Dow Theory Confirmation

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Seeking Ten Percent

Posted on September 25, 2010 by | Leave a comment
A reader asks:
“I see that your Watch List performance for the past 12 months is no better than the Dow's. How is that possible when you focus on the Dividend Achievers that are close to their 52-wk lows and do so much in-depth research and analysis?
“Am I missing something? If not, then how do you argue against just investing in something like a Vanguard index fund? Or, better still, there are value-oriented funds like those run by Tweedy Browne, et al, that have substantial outperformance to the market.
“Should your approach be modified to take into account the macro view first and then selecting the right sectors (from among the S&P 500's ten sectors) based on where the economy is in its growth/decline cycle? Thus, should the cycle analysis be used along with your present criteria to achieve outperformance?”
Our response:
These are all great questions. First, we’ll address the question of why bother doing all the work of researching these company if the final result is simply to underperform the Dow Jones Industrial Average. As indicated in the book Investing: The Last Liberal Art there is an element of joy in learning new things. We love the process of understanding the research into cell apoptosis that a drug company is doing. We love finding a book like Taking Chances: The Psychology of Losing and how to Profit from it which helps us to understand more fully the benefits of failing. We love stumbling upon mathematical "quirks" like Benford’s Law whereby it can be proven that the order and frequency of the first digit in a set of numbers can reveal that there is accounting fraud. Simply put, our research of stocks fulfills our desire to understand the world around us while we attempt to pursue the profit motive.
In pursuit of the profit motive, the goal of the New Low Observer is to obtain mediocre gains of 9%-12% in each investment that we make. This means that when a stock rises to the level that we’re comfortable with, within the designated range, we find the next best alternative that is on any one of our new low lists.
As mentioned before, we consider selling a stock when it reaches a gain of 10% within a year. All of the stocks on our September 25, 2009 watch list accomplished our goal of 10% well before the end of the one-year period. The table below is the best demonstration of our approach in action.
Symbol
days to 10%
Annualized gain
WMT
54
67.59%
CAH
44
82.95%
WEYS
208
17.55%
ABT
44
82.95%
NWN
162
22.53%
BCR
182
20.05%
LLY
52
70.19%
BDX
68
53.68%
PNY
84
43.45%
*based on September 25, 2009 Dividend Watch List
As you can see from the stocks above, in some cases, accomplishing 10% occurred much earlier than we would have expected. We like to think of returns of 10% in less than a year as a form of accumulated time. This means that if we gain 10% in 5 months, we have at least 7 months to sit back and study the markets. This is seven months where we can detach ourselves from the noise and chaos that normally distorts rational thinking. Obviously, this is an option that we exercise from time to time when we’re not sure of the market prospects.
The example that we provided in our performance review of Dividend Achievers from September 25, 2009 was actually the worst case scenario if you decided, for some reason or another, to buy and hold all of the stocks that were on the list at the time (not recommended.) As far as we’re concerned, we were out of those stocks long before one year as has been demonstrated with the Sell Recommendation section of this site. Again, we seek mediocrity in our investment strategy knowing that if 10% can be accomplished within a year then we have been exceptionally fortunate. As mentioned in previous articles, we only expect 1/3 of the stocks to achieve 10% in one year during a bull market. However, if a stock that you purchase is on our Dividend Watch List, you can be assured that you can hold the stock for the “long term” if you choose to do so.
Finally, we are constantly trying to keep abreast of the macro view of the markets and the economy. However, our best experience has been with the use of Dow Theory. Although not infallible, Dow Theory is intended to be an all encompassing guide to not only what is going on right now but also what to expect in the future up to three to nine months ahead. We’re cognizant of the fact that Dow Theory is only a tool and not THE answer to what the future holds. Therefore, we only apply Dow Theory as a tool for determining asset allocation. Charles Dow himself has been specific on the point that investors can still have their money at work in a bear market (during a recession or depression). The only change that needs to take place during such hard economic times is the expectation of returns. As we at the New Low Observer seem insistent on getting 10% during the good times, we must be willing to accept 5% during the bad times.

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Posted in Annualized return, book, Dow Theory

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New Low Team Beats NBER to the Punch

Posted on September 20, 2010 by | Leave a comment
 The New Low Observer (NLO) team has done it again on the economy, stock market and our “guess” of when the National Bureau of Economic Research (NBER) would declare the end of the recession that began in October of 2007.

 

First and foremost, the NLO team announced on July 24, 2009 (the initiation of the NLO site) that Dow Theory had indicated that we were definitely in a cyclical bull market. This ignores our article on February 11, 2009 titled “Convergence of Extraordinary Forces” that indicated that there would be a bottom in the market around June 2009. According to Dow Theory, a bottom in the stock market implies a trough in the economy as well.

 

Second, on August 22, 2009, the NLO team indicated that based on the Industrial Production Index (IPI) and the Dow Theory bull market indication the stock market and the economy were headed high.

 

Finally, along with our call to the end of the recession on August 22, 2009, we predicted that the NBER would “…proclaim June 2009 as the official end to the recession.” The headline out of the NBER today, September 20, 2010, is that “…a trough in business activity occurred in the U.S. economy in June 2009.”

 

Some of the articles can be verified with the postings on Seeking Alpha.com; which we cannot alter once published. Just look at the approximate date that the article was published since Seeking Alpha does not publish exactly when submitted.

 

Seeking Alpha Articles:

 

Subscribers to our site have received all indicated articles with any revisions of our view as appropriate. Anyone interested in subscribing by email can use the following link.

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Posted in bull market, Dow Theory, NBER, recessions