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Hey there seeking alpha readers: TRANSITION time. After spending most of the summer on short 3-4 week bicycle tours throughout New England and the Adirondacks, with some time working and writing in between, there is time for one last tour in the very near future once all the foliage comes out.... More
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  • Dow Theory And The Bull Market's Second (Ongoing) Test 2 comments
    Aug 9, 2012 1:45 PM | about stocks: DIA, IYT

    In articles I and II I outlined the principles of Dow theory and applied it to the market's action since, in my analysis, a Bull Market was signaled by action of the Industrials (NYSEARCA:DIA) and Transportation(NYSEARCA:IYT) averages in the spring of 2009. Dow Theory tells the investor to assume the bull market is ongoing until the following happens:

    • a secondary reaction of meaningful extent and duration occurs;
    • prices recover briefly and attempt to reach new highs;
    • the attempt fails and new local lows are set in both averages.

    We used these principles in arguing that the market gyrations in the summer of 2010 did not constitute a bear market signal.

    What about the market action in spring through early fall of 2011? In my opinion, a bear market was signaled and then almost immediately reversed. Why do I say this? First, look at the Industrials over this period.

    (click to enlarge)

    Notice the selloff from late April to late June. It clearly met time and extent requirements. The rally into July failed to set a new high and the summer collapse took prices to new lows. Thus the Industrials suggested a bear market had started. What about the Transports?

    (click to enlarge)

    The Transport selloff was a bit shakier in terms of extent; and prices, in fact, did recover to new highs in July while the DIA did not. I gave the DIA the benefit of the doubt and when prices collapsed to new IYT lows in July that average had 'confirmed' that a bear market was in progress. It sure felt like one! The numerous sharp selloffs into the fall seemed to fit the scenario as well.

    But what happened in the next few months? The surge in October was clearly a secondary reaction (rally) against the now prevailing bear market, and when prices marked time in November and December before going to new local highs in both averages just before Christmas, a new bull market had again been signaled. What do we make of this?

    Keep in mind the Dow Theory is designed to keep us on the side of a major long term trend. Bear markets do not last for 5 weeks; bull markets do not last 5 weeks..They are long term events related to economic and business developments. Thus, with the advantage of hindsight, it is better to just rewrite the entire selloff in the summer of 2011 as one single secondary reaction against the bull market that began in the Spring of 2009.

    Where does this bring us? The Industrials have, since, rallied to a new local high in February of 2012. So the Industrials have confirmed the ongoing bull market, now over 3 years old. But, notice the transports have not rallied above their July 2011 high of 100. Thus, the transports have not confirmed the bull market....yet. Under dow theory principles, we should assume the bull market is still in progress; but there is now some doubt.

    In order to confirm the Bull market the transports must surpass last summer's highs! We've been waiting a LONG time. But in dow theory such periods do, indeed occur, and they call for patience on the part of investors.

    I might add that some analysts believe a bear market was signaled this past May when the Industrials touched a high for the year, IYT did not, and then both indexes sold off. In my opinion these gyrations in SPY and IYT were not substantive enough, or lengthy enough, to be classified as secondary reactions. So I disagree with this view, although the continued punkiness of the Transportation average is a matter of concern to long term investors.

    Disclosure: I am long SPY, DIA.

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Comments (2)
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  • New Low Observer
    , contributor
    Comments (2060) | Send Message
     
    Greetings CS,

     

    There are several conflicting comments in the article as it relates to Dow Theory. However, we're going to cover the most obvious. First, you said:

     

    "What about the market action in spring through early fall of 2011? In my opinion, a bear market was signaled and then almost immediately reversed."

     

    You were correct that there was a bear market indication in 2011. But we have yet to have a reversal of the bear market indication. You have interpreted a bear market rally to be a bull market.

     

    Our work on the topic shows that a bear market was signaled on August 2, 2011. The divergence of the Industrials and Transports today is confirmation that the bear signal was correct.

     

    Alternatively, if it were a secondary bull market reaction, then to confirm that we are STILL in a bull market, which was signaled in 2009, we'd need to (expect) both indexes to exceed the prior highs set in 2011.

     

    Unfortunately, we've had only the Industrials exceed the highs of 2011 while the Transports have failed miserably. Not only has the Transports failed they've actually diverged significantly.

     

    The second comment that runs counter to Dow Theory is:

     

    "But what happened in the next few months? The surge in October was clearly a secondary reaction (rally) against the now prevailing bear market, and when prices marked time in November and December before going to new local highs in both averages just before Christmas, a new bull market had again been signaled."

     

    If you felt that we were truly in a new bull market then you'd be willing to interpret the market action by waiting for the confirmation of new highs in both indexes. Waiting for only one index to exceed prior highs isn't a part of Dow Theory.

     

    Which is substantiated by the following comment:

     

    "Keep in mind the Dow Theory is designed to keep us on the side of a major long term trend."

     

    You are right that Dow Theory is not intended for short-term signals. For this reason, Charles H. Dow has spoken often of 3-4 year bullish moves, as has Richard Russell (outlined in our article titled "A Market Cycle Worth Observing" found here:http://seekingalpha.co...).

     

    After a 3-year run of dual confirmed new highs and a bear market signal in 2011, divergence between the Industrials in both the secular (we didn't cover this part) and cyclical basis, the bear signal remains in place until the 2012 high in the Industrials is exceeded and the 2011 high in the Transports is exceeded.

     

    Regards.
    9 Aug 2012, 08:15 PM Reply Like
  • Gary Jakacky
    , contributor
    Comments (2496) | Send Message
     
    Author’s reply » let me quickly acknowlege your letter and I'll get back to you in a few days. I am busy cycling in this on-and-off stormy new england weather.

     

    Gary
    11 Aug 2012, 05:25 PM Reply Like
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