It's a Dow Theory Buy Signal: Time to Sell?

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, published Monday (August 10th):

...[F]or months we have opined that if a Dow Theory “Buy Signal” was eventually registered that so much energy would have been expended in achieving it the major market averages would likely be a “sell” on the event. And here we are, a Dow Theory “Buy Signal” has finally been registered and by our pencil so much energy has indeed been used to accomplish it we think the equity markets are a short-term “sell.”

Indeed, all of the macro sectors we follow are now VERY overbought. Specifically, 96% of the Financials are currently above their respective 50-day moving averages [DMAs]; and, all of the other macro sectors have at least 80% of their stocks above their 50-DMAs, save the Telecommunication sector, which stands at 67%. Moreover, as stated in the publication ChartWorks, “In eleven of the last fifteen instances the first year in a presidential term has produced a high around the end of July (or the first part of August)” and historically the August/September timeframe has often been volatile for equity investors.

Further, the recent rally has been accompanied by weak volume. As the astute Lowry’s service notes, “The greatest shortcoming of the rally from the March low has been the lack of volume.” Lowry’s goes on to observe, “Both short and intermediate term indicators of price momentum have reached levels that typically lead to market corrections.” Also worth considering is that our “day count” sequence is now at session 21, in the typical 17- to 25-session skein, and therefore the recent rally is pretty long of tooth. Hence, we think the Dow Theory upside confirmation should be sold on a tactical, or short-term, trading basis.

Of course, this “top picking” approach is not in keeping with the moving average strategy we have been advocating recently. To wit, over the past few weeks we have suggested that until the market average in question closes below its respective 10-DMA all investment / trading positions should be maintained. Such a strategy eliminates any “thinking” given its robotic approach. We still believe such a strategy makes sense for the more intermediate / long-term investor.

To be sure, for the past few weeks we have advised more “conservative types” to use some sort of short-term moving average violation before reducing positions. For our purposes, we have been using the 10-DMA. In the S&P 500’s case that moving average is currently at 983, while the DJIA’s 10-DMA is at 9125 and the NASDAQ Composite’s is at 1976.

Nevertheless, we sold some positions into last Friday’s Fling (+113 DJIA); despite the Dow Theory “Buy Signal.” Clearly, our short-term more cautious approach is at odds with current Wall Street thinking since the mantra du jour is that you should be “tactically bullish and strategically bearish.” However, as the brilliant GaveKal organization points out (as paraphrased by me):

“Meanwhile, we are starting to wonder whether the opposite view may make more sense – i.e., being structurally bullish while perhaps tactically reducing the risk in portfolios through the purchase of CDS, index puts, Yen and US dollar ‘calls’ and other negative carry trades. Consider the following: 1) On economic growth: The past two months have undeniably been marked by a sharp turn in leading indicators. But for most countries, this turn has been more a reflection of surges in monetary aggregates and upticks in surveys (PMI, consumer confidence...) than anything else. What investors will likely want to see going forward is stabilization in employment and a pickup in global trade. Confirmations of such could still be a few months off, leading to some nervousness in equities? 2) On corporate profits: There is little doubt that the violent rally of the past few weeks has mostly been triggered by the very solid corporate earnings reported. In itself, the strong profit numbers were not that surprising. Similarly, there is little doubt that, going forward, investors will want to see more than efficient cost-cutting. Companies able to deliver a genuine pick-up in sales, and not just in profitability, will be richly rewarded. But will there be many such companies in the next three months? 3) On inflation: The past few weeks have seen a serious abatement of inflationary fears with yields on US 10 year government bonds falling by over 50bp. But could inflationary fears start to creep up once again? Commodity prices are bouncing back, monetary policies everywhere around the world remain exceptionally un-constraining, fiscal deficits are surging almost everywhere.”

Plainly, we agree with the good folks at GaveKal that the next few months could prove testy for the equity markets. Additionally, we would apply that near-term cautious approach not only to the U.S. equity markets, but even to our beloved emerging and frontier markets given the outsized rallies they have experienced since the March lows.

If, however, you don’t embrace our near-term caution, we suggest doing what the underinvested money managers are being forced to do – buy lower volatility stocks with dividends. From Raymond James’ universe of stocks we offer Home Depot (HD), Chevron (CVX), CenturyTel (CTL), and Otelco (OTT). Other favorably rated names from our research affiliates include Pfizer (PFE) and Altria (MO).

The call for this week: Last week Goldman Sachs’ strategist, Abby Joseph Cohen, opined that we are now in a new bull market. While that “foots” with the Dow Theory “buy signal” we think she is a tad late to the party. Indeed, the S&P 500 is up 53% from its March 6th low and the NASDAQ Composite is up 59%. Those rallies have left the indices about as overbought as they can get. As Dick Arms, of The Arms Advisory, notes, “(The nearby charts) shows the 5-day and 10-day moving averages (for the DJIA).

There are usually two times when extremely low daily numbers persist enough to cause this size spike on the inverted chart. One is when we are coming off an extremely oversold (condition), so that a sudden compression takes place. That is what happened in early March, just as this bullish move began. The second is when the advance has gone too far and a correction is to be expected. That looks like what we are seeing right now.” Obviously, we agree.

Click here to enlarge
Source: The Arms Advisory.

Disclosure: No positions

Comments

[Ryu Mei Co:]

Oh yeah, the correction will be here.

The World market are moving ever higher, Shanghai Index is bubbly higher, Nikkei is over 10500 making higher highs every day, and Hong Kong is recording over 1%-2% rally for the past few days.......

Moreover, the Nikkei rallied on stronger Yen, 3 years of deflation, and lower consumer spending. You kidding me! I have never see this kind of BS market rally response before.

"Humpty Dumpty sat on a wall,
Humpty Dumpty had a great fall."

I just hope Humpty fall quickly and get over with it sooner than later.

Aug 11 05:03 AM

[TonyNasir:]

Good points made by the author. I would like to add the following:
Best way to judge a market is to look at the leader, i.e., Nasdaq in this case. A couple of things to note. Firstly, Nasdaq has lagged the $SPX lately and was unable to make new rally highs during the past week's rally while $SPX did! So, an important non-confirmation by the leader.
Secondly, Nasdaq has recently moved above it's 80-Weeks Mvg. Avg. (Currently around 1948.50). Historically, this is the level where the bull markets have started or the bear markets have peaked. If Nasdaq can manage to stay around it's 80-Weeks Mvg. Avg. during the next few weeks, odds favor start of a bull market. On the flip side, if the leading index (Nasdaq) breaks this important level to the downside decisively, chances of the end of bear market rally increase tremendously.
I won't attach too much significance to opinions of the perma-bulls like Abbey Joseph Cohen and Ken Fisher!

Aug 11 05:08 AM

[swaps:]

This morning I intuitively sold out two positions and half of a third as my account fell faster than the DOW for another day in a row.
Jeffrey Saut, I will start following you because your study of moving averages is a valuable piece of information to factor in.
Tony Nasir's observation on the 80-week average significance is interesting - but can a cash bailed out Fed manipulate around the historical markets?
Is Abby late to the party because her co-conspirators have pumped and now they want to dump, to boost their bonus numbers further?

Aug 11 11:42 AM

[vknox:]

Here's a good article for you...

Data Mining Isn't a Good Bet For Stock-Market Predictions
online.wsj.com/article...

"The Super Bowl market indicator holds that stocks will do well after a team from the old National Football League wins the Super Bowl. The Pittsburgh Steelers, an original NFL team, won this year, and the market is up as well. Unfortunately, the losing Arizona Cardinals also are an old NFL team."

Aug 11 02:30 PM

[untrusting ...:]

Good point..if Abbey Joseph Cohen is trotted out to pump the market for Goldman, given that she is always wrong, it is almost a certainty that Goldman Sachs has dumped most of their long inventory and oil positions and likely is building large short positions. After all as you note, GS has to maintain those multi-billion dollar bonuses and with very limited upside potential and large downside potential .... GS is much more likely to maximize bonuses by driving the market down now. Naturally they will be happy to do that for a large profit of course. Abbey Joseph Cohen may well be the best leading indicator there is.


On Aug 11 11:42 AM swaps wrote:

> This morning I intuitively sold out two positions and half of a third
> as my account fell faster than the DOW for another day in a row.
>
> Jeffrey Saut, I will start following you because your study of moving
> averages is a valuable piece of information to factor in.
> Tony Nasir's observation on the 80-week average significance is interesting
> - but can a cash bailed out Fed manipulate around the historical
> markets?
> Is Abby late to the party because her co-conspirators have pumped
> and now they want to dump, to boost their bonus numbers further?

Aug 12 12:31 AM

[Michael Del...:]

Paranoia strikes deep.
Into your heart it will creep ..........

Aug 12 06:00 PM

[Dividend Inc:]

Greetings,

You stated:
"[F]or months we have opined that if a Dow Theory “Buy Signal” was eventually registered that so much energy would have been expended in achieving it the major market averages would likely be a “sell” on the event."

I am curious to know in which articles you specifically stated that the Dow Theory buy signal, 'would likely be a 'sell' on the event." I wish to examine the context around your thesis on the matter. Thanks.

Aug 17 11:24 AM