Dow Theory Update For January 8th: Primary Bear Market For US Bonds Signaled On January 6th When One Takes The Long-Term Interpretation Of The Dow Theory

Summary

• Trends in precious metals unchanged.

US INTEREST RATES

General Remarks:

In this post, I provided a thorough explanation concerning the rationale behind my use of two alternative definitions in order to appraise secondary reactions.

TLT is the iShares 20 years + Treasury bond ETF. More about it here

IEF is the iShares 7-10 years Treasury bond ETF. More about it here.

Thus, TLT tracks longer-term US bonds, whereas TLT tracks middle term US bonds. A bull market in bonds entails lower interest rates. A bear market in bonds represents higher interest rates.

A) Market situation if one is to appraise secondary reactions not bound by the 3 weeks and 1/3 retracement dogma.

The primary trend was signaled as bearish on October 5^th, 2020, as was explained in-depth here.

As I explained here, the small rally that developed off the 11/10/2020 closing lows to the 11/20/2020 closing highs doesn’t qualify as a secondary reaction, so the secondary trend remains bullish. However, a “line” (narrow range) developed which was broken down on January 6^th. The violation of that line reconfirms the primary bear market.

The charts below give you a visual update of the current situation.

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks and 1/3 confirmed retracement in order to declare a secondary reaction.

The primary trend was signaled as bullish on 12/18/2018, as was explained here.

The secondary trend was bearish (secondary reaction), as was explained here. Off the 11/24 closing lows there was a rally that setup TLT and IEF for a primary bear market signal.

On January 6^th, 2020 the 11/24/2020 lows were jointly broken down and, accordingly, a primary bear market was signaled. The charts below display the current situation. The red horizontal lines display the 11/10/2020 closing lows whose breakdown implies a primary bear market signal.

Since also a “line” was broken down, I feel this is quite bearish. Not only the “typical” setup resulted in a primary bear market signal but also a “line” was broken downside.

Let’s take a look at how this trade fared by looking at the table below:

As a trader, I don't favor making a commitment to IEF due to its low volatility. IEF’s lower gain on this Dow Theory trade is entirely due to its swinging much less than TLT. As a reminder, TLT is based on +20 years bonds, whereas IEF is based on a much shorter-term duration (7-10 years). While being necessary to derive DowTheory signals (confirmation), IEF is not necessarily the best vehicle to invest in. However, those wanting to play very conservative might allocate some of their funds to IEF. Up to each trader.

We can see that the long position lasted slightly more than 2 years.

As an aside, in my post of 11/9/2020, I alerted about the likelihood for a reversal. I quote:

“By the way, TLT’s confirmation of the higher highs made by IEF took quite a long time, namely more than 4 months. Belated confirmations tend to be a warning sign about the underlying health of the trend.”(Emphasis supplied).

While warning signs are on themselves not necessarily enough reason to act (i.e., to partially or totally sell), as we are trend-followers, they serve to validate further the signal we have got today. However, when such warning signs pile up (i.e., belated confirmation, divergences, ominous volume readings, price objectives reached, etc.), there would be nothing wrong with unloading “some” provided the trader has a definite re-entry plan. This is what we suggested in our September 1st, 2020 Letter to our Subscribers for US stock indexes. The pullback that followed attested to the wisdom of partially lightening up.

Sincerely,

Manuel Blay

(One Dow Theorist)