Dow Theory Warnings Continue

Several months ago, I wrote back to back articles about the Dow Theory trend change. You can view them below.

http://www.investfortomorrow.com/newsletter/CurrentStreet$marts20141103.pdf

Simply put, this analysis holds that the Dow Jones Industrials and Transports should move in lock step to confirm each intermediate-term move in the stock market. When one index see a relative new high, so should the other. The opposite is true at lows. When one index diverges from the other, it is a possible sign of a trend change. When both indices closes below a previous significant low that is considered confirmed change of trend.

Let’s look at the two charts below for some real life, recent examples. At the far lower left of both charts you can see the Ebola October lows where both indices closed below previous significant lows. By early December, they both went right back to new highs where the party began to fizzle.

Since early December, the transports have seen a progression of peaks that were each lower than the previous one where the industrials saw a clear trend of higher highs through February. With one index lagging the other, this is called a non-confirmation or divergence and warns that all is not perfect healthy. Of course, if and when the lagging index rallies to confirm the leader, this Dow Theory warning completely goes away. Right now, we have a series of caution flags since late 2014 without much in the way of price weakness.

Beyond the Dow Theory non-confirmation discussed above, the more serious warning is the Dow Theory trend change. This occurs when both indices close below previous significant or above previous significant highs. On the left side of the chart in October, both indices saw Dow Theory trend changes to the downside that were immediately reversed. In other words, the October warning failed.Today, the transports are getting close and should breach the low points seen from December through February. The industrials have another 600 points to go, but don’t dismiss that as out of the question. I do believe, however, that if the industrials fall much more to signal a negative Dow Theory trend change, it will be short-lived like we saw in October.
Although the Dow Industrials and Transports are not and have not been perfectly in sync for many months, the broad stock market has been acting okay and lacking most of major signs that the bull market is ending. More than likely, any weakness this quarter will be of the ending nature, completing the divergence seen in the two major indices as the Dow Industrials prepare an assault on 20,000.
If you would like to be notified by email when a new post is made here, please sign up, HERE.

Dow Theory Trend Change… Again

Last week, I wrote an article explaining how traditional Dow Theory worked, at least the way I learned that it worked. In that piece, Dow Theory confirmed a trend change to the negative side. While describing what transpired to give this warning, I also wrote that my own projections for the Dow were to the 18,000 level and I would be surprised if stocks didn’t see all-time  highs.

After the Japanese caught the markets off guard with their own shock and awe on Friday, we have yet another Dow Theory Trend Change and in doing so, wiped away any early warning sign that Dow Theory was giving. Both the Dow Jones Industrials and Transports are at new highs, a late confirmation for the bulls, but a confirmation nonetheless. This sudden shift from one side to the other and back again is often referred to as a whipsaw and definitely exposes one of the weaknesses in Dow Theory.

Below you can see what I tried to depict above in chart form. Stocks have run very hard, very fast and are certainly due for a breather. But as I have said for several years, the bull market remains alive. Any and all pullbacks are buying opportunities until proven otherwise.

Tomorrow, be on the lookout for a special election post!

If you would like to be notified by email when a new post is made here, please sign up, HERE.

Dow Theory Trend Change

Dow Theory has been around for decades and it’s not something I discuss very often. You can Google it to find newsletters and blogs and opinions on its value. As the stock market gets closer and closer to the final bull market peak, I think it’s something we should watch.

Dow Theory works in a couple of ways and I am going to focus on one piece here, primary trend change. Dow Theory Primary Trend Change occurs when BOTH the Dow Jones Industrials and Transports close above or below a previous secondary high or low. In essence, the trend of the market is said to have changed when lower lows are made during an uptrend or higher highs during a downtrend.

Earlier this month as you can see below, both the Industrials and Transports closed below their previous secondary lows from August. At that point, Dow Theory says the trend changed from up to down. Of course, that was also the stock market bottom I called in real time to contradict Dow Theory. Anyway, today, Dow Theory is still in a downtrend until both the Industrials and Transport make new highs which the latter did today. With my own upside target still 18,000, I would be surprised if the Industrials do not see all time highs and another Dow Theory Trend Change and whipsaw.

What would cause me much greater concern is if the Transports saw new highs, but the Industrials do not. That is called a Dow Theory divergence or non confirmation and often warns of a larger decline possibly unfolding.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

Two Market Scenarios for the Quarter

In the last issue of Street$marts, I wrote about stocks being in a “murky” period for the next few weeks. I am going to pat myself on the back and say it has certainly looked “murky” since early October although I wish I had been more aggressive in taking action. The dark clouds have recently dissipated and the sun is starting to pop out. Once the decline began, it looked like the second half of October would see a low and that’s been confirmed.

I recently shared research that indicated a 15% chance of a 8-11% decline during the Q4. This was based on the S&P 500 seeing a fresh high in September or October which usually insulates the market from much more than a 10% decline. So far, on a closing basis the Dow and S&P 500 have dropped almost 7% and 7.5% respectively, and 8.6% and 9.4% on an intra-day basis. The other major indices have seen more significant weakness.

Either by skill or luck, I am always happy to nail a low as it occurs, especially now, when so many others were calling for much more serious damage. With the world fixated on Ebola, Europe’s economy, earnings and ISIS, fear was prevalent last week, the likes of which we haven’t seen since mid June and in some cases, 2011.

So far, all we know for sure is that “A” bottom was achieved. Whether it was “THE” bottom remains to be determined. If prevailing sentiment becomes “sell the rally”, the upside is likely to continue. However, if the masses believe that we just saw the final bottom of 2014 on the way to new highs, a more difficult path will be in store as I discuss below.

I continue to watch two scenarios as the most likely paths over the coming months. The green line in the chart below is obviously the more bullish of the two. It has last week’s low as “THE” low from which the year-end rally has already launched and all time highs are to be seen within a few months. The orange line forecasts a lot more volatility with the currently rally petering out shortly and marginal new lows seen within a few weeks. From there, the real rally begins, similar to 2011, with higher prices down the road.

 What is obviously missing from the scenarios above is a truly bearish one that has the bull market already over and this current rally representing a good selling opportunity leading to sharply lower prices right into the New Year and beyond. At this point, I just don’t see it. We simply do not have enough dead canaries to warrant such a negative outcome. And speaking of dead canaries, I will update the Canaries in the Coal Mine next week.

For now, the takeaway is to watch for signs that the rally is hitting stumbling blocks. High yield (junk) bonds had a truly epic day on Friday, recovering five days worth of declines in one day. That nascent advance must live on. Good sector leadership needs to emerge and not from consumer staples, utilities and REITs. Although the banks are a bellwether sector, the bull market can live without them for a while longer, but that will likely lead to the eventual demise.

Before I finish this article, there are things that concern me. It’s not all roses out there! After 67 months, the bull market is showing its age. Traditional Dow Theory just gave its first negative trend change in some time as both the industrials and transports closed below their August secondary lows. That’s long-term problematic unless both make fresh all time highs in the coming months. What would bother me even more is if one index scores a new high, but the other one does not. Anyway, we have time to explore this further next week.

If you would like to be notified by email when a new post is made here, please sign up, HERE.