Current
Signal Performance as of
Signal
Type |
Trade
Date |
Return
since issued |
|
|
|
World |
U.S. |
|
Nasdaq
100
(QQQQ)
|
Russell
2000
(IWM)
|
S&P
500
(SPY)
|
|
After weeks of gains, stocks marked a pause and were little changed over the five-day span. The main indexes retreated modestly Monday as investors booked some of their profits following last Friday's big rally, resulting in a 0.5% daily loss for the Nasdaq Composite. A disappointing reading on consumer confidence initially sent stocks lower Tuesday morning, but the market was able to show its strength by staging a positive reversal to close with gains on heavy volume. After a quiet session Wednesday in which stocks traded in a narrow range, the major averages opened higher Thursday following a batch of positive economic news: weekly jobless claims were better than expected, GDP for the second quarter came in above views and the Chicago PMI index also topped estimates. The initial gains did not last, however. It is very often the case on the last day of the quarter, as typical window-dressing action prompts institutional investors to book profits. Stocks finished the day lower as a result, but the losses remained modest, only causing a 0.3% drop for the S&P 500. Equities finished the week on a positive note Friday with the S&P 500 gaining 0.4% on solid economic news: personal income and spending rose more than expected in August, as did construction spending.
The Russell 2000 (IWM) gained 1.30% over the five-day span, while the S&P 500 (SPY) and Nasdaq 100 (QQQQ) respectively lost 0.18% and 1.31%. All three ETFs remain located above both their 50-day and 200-day exponential moving averages (EMAs).
For its part, our World portfolio outperformed its U.S. counterparts by posting a 2.40% gain this week. The portfolio consists of the 5 top-ranked world ETFs as of September 10, which marked the beginning of the current 4-week holding period.
Our current Buy signal remains in effect.
The Dow Theory
This past month, markets have resumed their uptrend, showing
again some positive performance numbers year-to-date after many
back and forth oscillations during the previous months. So to
this regard, the Dow Jones Industrial Average
has finally joined its sibling the Dow Jones Transportation
Average
in setting new highs. As you can see from the graph below, the
Dow Jones Transportation index is slightly more volatile, and
often sets the tone of the market before the other index. You
are probably wondering why we focus today on these two indexes?
This is because they were at the heart of the so called Dow
Theory.
Figure 1: YTD Graph of the Dow Jones Industrial and
the Dow Jones Transportation
No, the Dow Theory is not yet another Dow Jones index. It is
one of the earliest market timing systems in existence, and
its first characteristic is that it is not really a single theory
but rather a broad body of work developed over more than a century
by many people. We certainly are no experts in the Dow Theory,
and it plays no role in our Trend Timing system, but we thought
it would be timely and interesting to introduce and compare
this long evolving trend following system.
Initial developments by Charles Dow in the late 19th
century and extensive refinements by William Hamilton during
the first quarter of the 20th century were only known
through their publication in numerous articles in the Wall Street
Journal, of which Dow had been a co-owner. Robert Rhea is credited
with documenting and assembling a lot of the earlier works.
After years of quasi dormancy the theory was picked up again,
modified and extended far beyond the initial Dow version by
many more Dow Theorists such as George Schaefer and Richard
Russell to name only two. In the last 10 to 20 years the number
and variety of Dow Theory newsletters and advisors have mushroomed.
Over the years it has become almost a cult-like phenomenon with
tight circles of enthusiasts loudly proclaiming the superiority
of their version and interpretation of the theory.
The vast majority of the initial work was purely what we now
would call technical analysis of market indices, and was pitched
directly as a substitute to emotional investing. It did in its
principles have some commonality with our Trend Timing by identifying
the predominant trend, participating in the big moves, and sidestepping
downtrends. Dow theorists view individual stocks as way too
risky, hard to predict and susceptible to manipulation so, much
like us, they mostly rely on index investing.
One of the most important rules are Dow Theory confirmations,
meaning that for a Dow Theory signal to be valid, when one index
sets a new high or new low, the other must follow soon.
This is one of the basic tenets of the Dow Theory also defined as:
- A
bull market begins when a bull trend on one index (marked
by a new high) is confirmed by the start of a bull trend
on the other index
- A
bear market begins when a bear trend on one index (marked
by a new low) is confirmed by the other index
The two
indices in question used to be the Dow Jones Industrial and
Dow Jones Rail averages, but the latter has long since been
supplanted by the Dow Jones Transportation index.
Lately, this is the pattern that we have seen with both indices
making simultaneous new highs while (and this is important) the
corresponding lows are also on an ascending trend.
Ironically, where the theory really began as a clear-cut mechanism
to identify the primary trend with no room for interpretation,
it has for years become fragmented with clearly divergent
interpretations. Economic factors and market psychology have
been added to the mix with ingredients such as valuation,
economic environment, and investor sentiment, all requiring
a subjective assessment. How the Dow Theory signals or breakout
points are measured varies greatly from one advisor to the
next. The strength of the confirmation is dependent on how
close in time it is. The more time passing before confirmation,
the weaker it is said to be. Even the definition of a new
high is interpreted very differently. For simplification, we will say that
significant higher highs accompanied with higher lows is commonly viewed as a
good indicator of a new uptrend.
One of the primary criticisms of the Dow Theory is being consistently
late and missing large parts of the big moves. Indeed, waiting
for a new high means that you already left behind part of
the uptrend, so it is only viable when pursuing long term
trends since there will be inevitably some minor pullbacks
while the bull pattern is developing.
As usual, we will stay clear of interpretations and predictions
and rely on our simple 100% mechanical model to point to the
primary market trend.
Question:
Should I get invested now or wait for the next signal?
This question comes up frequently, and not just from new subscribers
arriving mid-signal, but whenever you get some new capital to
invest, like your quarterly 401 (k) deposit or a bonus. The
reluctance to invest between signals is obviously because of
the risk that shortly after investing, the market will reverse
and trigger a signal for losses. It is of course for each of
us to decide, but because we have had signals that lasted over
a year and that the long ones also tend to generate substantial
gains, we generally recommend getting in with the signal. We
don't know when the next signal will come, but you do not want
to be sitting on the sidelines for possibly many months without
participating in the market. In order to reduce the entry risk
we recommend easing in with a series of investments over a few
weeks per the dollar cost averaging technique we detailed in
the April
02, 2010 Trend Timing School article.
Warm wishes and until next week.
The TimingCube
Staff
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