New Dow Theory Signal - What Does It Mean For Stocks?

July 5, 2017

Charts Monitor, Rather Than Dismiss Fundamental Data

Critics of technical analysis often mistakenly believe that using charts discounts the importance of fundamental data, such as earnings, employment, and economic growth. Charts allow investors to monitor the aggregate investor interpretation of all the fundamental data. Said another way, charts are efficient tools allowing us to monitor vast amounts of fundamental data, which is important since fundamentals ultimately determine the market’s long-term fate. When the economy is healthy, stocks tend to beat bonds. When economic fear dominates, bonds tend to beat stocks. In this article, we will cover the latest signal from the markets that came on July 3.

Dow Theory Is Based On Economic Common Sense

Dow Theory is based on a series of Wall Street Journal articles written by Charles Dow. The basic tenets of Dow Theory are easy to understand. Charles Dow believed that:

  1. In order for industrial companies to increase their earnings, they had to produce and sell more goods.
  2. If industrial companies are selling more goods, then transportation companies must be delivering more goods to retailers and wholesalers.
  3. Therefore, in a healthy economy, both industrial companies and transportation companies should be experiencing revenue growth.
  4. If industrial and transportation companies are growing their revenues, then the industrial and transportation stocks should be attractive to investors.
  5. If industrial and transportation companies are doing well and are attractive to investors, both the Dow Jones Industrial Average and the Dow Jones Transportation Average should be making new highs, serving to confirm a healthy economy.

Behind The Averages

After reviewing the companies in the industrial and transportation averages, it is easy to see why they represent logical vehicles to monitor the pulse of the U.S. economy. In 2017, our economy is driven by more than just industrial or manufacturing companies. The present day Dow Jones Industrial Average contains traditional producers, such as IBM (IBM), 3M (MMM), Boeing (BA), Chevron (CVX), and Johnson & Johnson (JNJ). However, the Dow (DIA) also contains Visa (V), Goldman Sachs (GS), and American Express (AXP), since the present day economy relies heavily on the financial sector. The Dow Jones Transportation Average (IYT) still has railroads, such as Union Pacific (UNP) and Norfolk Southern (NSC), but it also contains more modern logistics companies, such as United Parcel Service (UPS), Fed-Ex (FDX), and J.B. Hunt (JBHT).

Just Reconfirmed Primary Bull Market

If investors believe industrial and transportation stocks are healthy and thus, attractive investments, that speaks to demand. When demand is strong, stock prices rise. Despite recent stock market volatility, the Dow Jones Industrial Average broke out and posted a new high in early June. Notice the slope of the blue 50-day moving average in the chart below; you can compare it to the early stages of a 2011 correction in stocks and to the 2008-2009 bear market later in the article.

Similarly, the Dow Jones Transportation Average also posted a new high on July 3. Again, note the look of the blue 50-day moving average.

How Can Stocks Continue To Climb With Weak Growth And The State Of The World?

This week’s stock market video addresses two major questions: (1) Is the party ending for the NASDAQ? and (2) Have stocks exceeded expectations in the past after a period of tepid growth and political instability?

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2011: How Can This Help Us Manage Risk Today?

If Dow Theory offers a way to monitor the aggregate interpretation of the economy, earnings, and central bank policy, then we would expect charts of the DJIA and DJTA to be helpful in terms of managing investment risk. Since a picture is worth a thousand words, when the Dow’s 50-day rolled over in 2011 (see orange arrows below), the index dropped an additional 16%. Notice how the Dow failed to make a new closing high before the big reversal in 2011. As of July 2017, the 2014 Dow chart looks much better (slope of 50-day is up, recent higher high).

2007-2009: Economic Pessimism And Investor Fear

Similar economic warnings came in 2007 and 2008 (see orange arrows in chart below). Notice during the 39% drop in the Dow in 2008 the 50-day never gave a “things are improving” signal, meaning it was helpful from a cash-redeployment perspective. In late 2007/early 2008, Dow was not making new highs; instead it was making a series of lower lows, which reflected a period of economic pessimism and investor fear. The 2017 chart of the Dow looks much better, which is indicative of more favorable economic expectations.

The differences are easy to see side-by-side. The stronger bullish conviction tells us even if stocks pull back in the short-run, the odds are good that buyers would step in and attempt to test the recent highs. Reversals tend to be a process rather than a one-day binary event. The charts below speak to probabilities.

Investment Implications – Time To Pay Closer Attention

Does the recent Dow Theory bullish confirmation mean it is all fun and games for the economy and stock market? No, it simply tells us the market is currently healthy and the next bout of significant weakness is more likely to be a correction, rather than a full-blown bear market. A correction always remains a possibility in 2017.

For Further Study

  1. Are Stocks In A Bubble That Is About To Burst?
  2. Will Narrow Framing Cause Many To Miss A Generational Rally In Stocks
  3. How Concerning Are Predictions Of A Stock Market Crash?

NASDAQ Party Over?

June 30, 2017

Part II: How Can Stocks Continue To Climb With Weak Growth And The State Of The World?

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Most Recent Comments Via Twitter

June 26, 2017

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

Are Stocks In A Bubble That Is About To Burst?

June 23, 2017

Bubbles Are Characterized By Building Euphoria

During investment bubbles, the gains over the years reach near-silly levels. For example, the last 17 years of the dot-com bubble featured an 1,800% rise in the NASDAQ (first chart below). With an 1,800% on the books, some investors made numerous extravagant purchases (super cars, beach houses, and fur coats). A NASDAQ investor who looks back 17 calendar years in 2017 is currently sitting on a gain of 24% (second chart below).

Euphoric Gains vs. Tepid Gains

Not many people have made extravagant purchases over the past three years based on their investment gains. No one is euphoric with a 24% gain that was earned over a 17 year period; the term disappointed seems a better fit.

Does History Say The S&P 500 Bull Market Is Living On Borrowed Time?

A headline such as “Happy Birthday Bull Market, It May Be Your Last” implies that a bear market is just around the corner. This week’s video looks at the history of secular trends to water test the “this bull market is living on borrowed time” theory. After reviewing the historical facts, you can make your own call.

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How To Develop A Euphoric Investment Climate

It is easy to see how a 1983 NASDAQ investor became irrationally exuberant over time. An investment in the NASDAQ in 1983 produced, for the most part, a source of positive investment feedback for 17 years. During this period, anyone with an even remotely long investment horizon was making money, which eventually led to the bubble trademark expression “this time is different”. In the charts below: (1) relative to the cost basis, the investment showed a gain when the NASDAQ was inside the green box, (2) relative to the cost basis, the investment was at a loss when the NASDAQ was inside the red box.

Getting Back To Break Even

Over the past 17 years, the more common expression has been “I’d be happy just to get back to where I was before”, which was not heard during the final euphoric stages of the tulip bulb mania, dot-com bubble, or housing bubble.

Looks More Like A Generational Opportunity

As outlined in detail on May 30, 2016-17 looks more like a major bullish turn than a major topping process. Other recent posts featured bullish-leaning data related to volatility and very-long-term breakouts in semiconductors.

What Does History Say About Valuations?

Valuations are a reasonable area of concern. While the conclusions may surprise some, a review of historical facts on January 7, 2017 moved those concerns out of showstopper territory.

Link To See It Market Post

June 21, 2017

LINK: How Does 2017 Compare To Stock Market Peaks In 2000 And 2007?.

Will Narrow Framing Cause Many To Miss A Generational Rally In Stocks?

June 19, 2017

We Tend To Make The Same Mistakes Over And Over

If you are perplexed by the post-election strength in U.S. stocks, it may be helpful to take a giant step back. From The Wall Street Journal:

Many of the financial mistakes people make are caused by a fundamental shortcoming: They can’t see the big picture. In behavioral economics circles, this is known as “narrow framing”—a tendency to see investments without considering the context of the overall portfolio. Many people are vulnerable to it.

Technology stocks provide an anecdotal example of narrow framing. As shown in the chart of the NASDAQ 100 ETF (QQQ) below, the short-term view has been marked by unsettling volatility.

However, if we look at the NASDAQ from 60,000 feet, we see a much more encouraging picture. The narrow view says “tech stocks have gone up for years and may be in a bubble”. The longer-term view says, “the NASDAQ was able to make it back to the highs made in 2000, and recently broke out of a 20-year period of consolidation.”

The Three Most Important Questions For Investors

This week’s video looks at long-term economic and financial market evidence to address the question “does history support the notion that the world is on the brink or that things tend to gradually get better over time.” The video covers numerous charts to assist in combating the human tendency to focus on narrow timeframes.

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Short-Term Focus Can Be Harmful

With smart phones and computers making balances, quotes, and P/L accessible 24-7, it is easy to fall into narrow framing mode. From The Wall Street Journal:

The easiest way to achieve your long-term goals, and avoid focusing on short-term losses, is to check your portfolio less often. While it’s now possible to get instant updates on the latest swings of the market, this additional information can lead to narrow framing. This is what the best investors do: They seek out the big picture. And then, once they’ve found it, they remember not to look at it too often.

What about earnings and valuations? Both are reasonable areas of concern. While the conclusions may surprise some, a review of historical facts on January 7, 2017 moved those concerns out of showstopper territory.

The Three Most Important Questions For Investors

June 16, 2017

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How Concerning Are Predictions Of A Stock Market Crash?

June 12, 2017

Forecasting Is Difficult At Best

Typically, several times a year headlines contain predictions about a coming stock market crash. Calendar year 2017 is no exception with recent bearish calls coming from Jim Rogers and David Stockman.

Since markets are an extremely difficult and complex animal, our purpose here is not to criticize anyone, but rather to highlight the “grain of salt” nature of any stock market forecast. The dated headlines below featured similar gloom and doom calls, and yet, global markets remain near all-time highs.

The headlines above appeared on BuisnessInsider.com and MarketWatch.com. It should also be noted that crash probabilities have hit “pay attention” levels a handful of times over the last few years. For example, the market’s risk-reward profile in October 2011 and February 2016 left the door open to a multiple year bear market. In both cases, stocks righted themselves and the hard data began to improve in a meaningful way.

An Extremely Rare Stock Market Shift Recently Occurred

This week’s video covers a rare market shift that has only occurred two other times in the past 28 years. The video also compares 2016-17 to the 1987 crash, dot-com peak, and financial crisis to help us better understand the odds of bad things happening relative to the odds of good things happening. After reviewing present day facts relative to historical facts, you can make your own call.

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Scary Headlines Are Not Uncommon

Given the difficult nature of attempting to predict a complex future, our approach will continue to focus on the facts we have in front of us today, rather than headlines similar to the one below that was published on April 11, 2014. Markets can do anything at anytime, which highlights the need to remain flexible and open to all outcomes, from extremely bullish to extremely bearish.

Could A Multiple-Year Rally Be In The Cards?

Instead of a crash, is a surprising multiple-year rally within the realm of reason? As outlined in detail in a May 30 article, 2016-2017 looks more like a major bottom than a market that is forming a major top.

Market Shift Has Occurred Twice In Last 28 Years

June 9, 2017

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Will Small Caps And Mid Caps Continue To Underperform?

June 7, 2017

Today’s post can be found on See It Market.