Praveen Chawla's  Instablog

Praveen Chawla
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I taught my self investing after I got tired of losing money in the hands of so called "professionals" over the years. I figured it's better if I lose my own money - at least I can blame no one else for my mistakes. I immigrated to Canada from India in the 80's with $10 in my pocket and have not... More
  • Despite Over-Valuation Bull Market Is Still Intact 0 comments
    Jun 3, 2014 1:08 AM

    I have always been a little skeptical of technical analysis but having missed both the bear markets of this century (and going into them fully invested) I take it more seriously now. Following my last debacle in 2009, where I temporarily lost more than half my net worth, I developed a new appreciation for being in sync with the primary trend. The fact is that it does not matter how good your stock selection is, if you are caught with your pants down in a bear market, you are going to get it good where it hurts.

    There is a lot of evidence accumulating that the market is over valued on a fundamental basis. Some of these metrics are Shiller P/E 10, Market-Cap to GDP and Tobin's Q. Morningstar's fair value graph indicates the US equity market is slightly overvalued. Even David Tepper the best performing hedge fund manager of 2013 has this to say,

    "Now is the time to have some cash. If you're 120% long here, it's probably not a good idea. I am nervous, it's probably nervous time. We've been in this stupid trading range for awhile. I'm not saying be short, I'm saying don't be too frickin' long."

    Like many of you, I am sitting on some big "hard earned" gains from the last 5 years and like many of you I am not convinced that we are near the top. As John Maynard Keynes famously said that "The market can stay irrational longer than you can stay solvent". The final phase of the bull market can be a really blow-out where you can gain another 30% to 40% or so of your total bull market gains. I am happy to give up the final 10% of my gains in exchange for not losing 20 to 50% in the inevitable bear market, but am loath at getting out too soon. Given the low interest rate environment and lack of exuberance (especially in seeking alpha) I don't feel too nervous. My simple system of broad technical indicators indicate that I should still stay in the market.

    Dow Theory.

    I have been following this system for a few years now and it has served me well by keeping me in the market since 2009. Mark Hulbert at Marketwatch summarizes Dow theory "sell signal" succinctly,

    •Step No. 1: Both the Dow Jones Industrial Average and the Dow Jones Transportation Average must undergo a "significant" correction from joint new highs.

    •Step No. 2: In their subsequent "significant" rally attempt following that correction, either one or both of these Dow averages must fail to rise above their pre-correction highs.

    •Step No. 3: Both averages must then drop below their respective correction lows.

    As shown in the chart below DJTA seems to be on steroids and the DJIA has hit a new high. This would indicate that this is no time to get out of the market.

    (click to enlarge)Dow Theory indicates bull is intact

    Moving averages

    I keep track of the 200 day and 50 day exponential moving averages and both these indicate no cross over which would indicate a trend change over. There is practical evidence based on the work of Mebane Faber and Morningstar that momentum investing works and one should strive to side with momentum whenever possible.

    (click to enlarge)No cross over of 200 and 50 day ema


    While my left brain appreciates that the market is somewhat over-valued my right brain is telling me to stay the course. My technical indicators are strong and until they turn, I intend to keep riding this bull.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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