Macro Monday 17~Bear Market Confirmed? Macro Monday 17
The Dow Theory Confirms Bear Market
Today’s post may be thee most important Macro Monday of 2023 as it may be a key moment where we received technical confirmation of a change to a bear trend.
What’s Got Me Rustled?
Manuel Blay, the lead economist and editor from the Dow Theory has recently confirmed an S&P500 bear trend change to his subscribers. Why is this so important? Historically, the Dow Theory has provided some of the best signals for market participants. From 1920 to 1975 the Dow Theory signals captured 68% of the moves in the Industrial & Transportation Averages and 67% of those in the S&P 500 Composite Index.
Over recent years I have been keeping an eye on The Dow Theory’s predictions and they were one of the few who signalled a warning in early 2001 before the Dot.Com Crash in Sept 2001, and they signalled a warning prior to March 2020 COVID-19 Crash. They were also one of the few who turned bullish on the market from November 2022 when bears were out in their droves.
The Dow Theory has a proven track record of outperforming the stock market with significant drawdown reduction (less skin in the game during downturn periods). The Dow Theory is one thee most top ranked investment letters and people will pay very close attention to this recent release by Manuel Blay.
What is Dow Theory and How Does It Work?
There are many elements to the Dow Theory and I am going to try and explain some of the basics with the help of some charts.
In basic terms the Dow Theory is a technical framework that predicts when the market is in an upward trend if one of its averages (Such as Dow Jones Transportation Average) advances above a previous important high, accompanied or followed by a similar advance in another corresponding average (such as Dow Jones Industrial Average).
The theory is predicated on the notion that the market discounts everything, consistent with the Efficient Market Hypothesis. Efficient Market Hypothesis is something I live by, it is the hypothesis that states that share prices reflect all information, price being the aggregation of everything that’s happening. Price over everything, over the news and any other outside factors. Consistent alpha generation is possible focusing only on price. This hypothesis chants “the market knows best” or “trust the intelligence of the market/price”). The Dow Theory uses a combination of markets to help achieve agreement for the overall market trend using price.
In such a paradigm, different market indices must confirm each other in terms of price action and volume patterns until trends reverse. This means that one chart can lead another. It also means that if multiple charts are confirming a particular trend, this adds weight to the probability that that the new price direction is the new trend. This is important to understand as today we will see that out of the four most common charts used by the Dow Theory, three of them are confirming the bear trend and the fourth is leaning bearish (the final confirmation outstanding).
“The Dow Theory for the 21st Century” by Jack Schannep should be your go for a more detailed understanding of the Dow Theory or visit the TheDowTheory.com and become a subscriber.
The Bearish Signals are here
As noted above the Dow Theory mainly focuses on the price movements of four major market indices all of which we will individually cover on today’s Macro Monday:
1. S&P500 – Three Bearish Signals
2. Dow Jones Industrial Average Index – Three Bearish Signals
3. Dow Jones Transportation Average Index – Three Bearish Signals
4. NYSE Arca Major Markets Index – Two Bearish Signals (one pending)
S&P500 - SP:SPX
The price and price structure on the S&P500 chart has provided us with 3 key bearish confirmations (see Chart 1 Above)
Dow Jones Industrial Average Index - TVC:DJI
The DJI is significantly more bearish than the S&P500 as it failed to make a new high since its high in Jan 2022 whilst the S&P500 broke to new highs in July 2023. We could consider this as a negative divergence with the DJI providing us an advance warning due to its failure to establish a new high in July 2023, instead it confirmed a lower high.
The price and price structure on the TVC:DJI Chart has provided us with 3 key bearish confirmations also (see Chart 2 Below).
Dow Jones Transportation Average Index - DJ:DJT
Similar to the Dow Jones Industrial Average (DJI), the DJT also confirmed a lower high in July 2023 compounding the bearish signal already observed in the DJI. These could also be considered double tops with a lower high for the latter two.
The price and price structure on the TVC:DJI Chart has provided us with 3 key bearish confirmations also (see Chart 3 Below).
NYSE Arca Major Markets Index - TVC:XMI
Similar to the S&P500 the XMI chart made a higher high in July 2023 however this was a false break out followed by a throw over with price then falling through the 21 week moving average.
The price and price structure on the TVC:XMI Chart has provided us with 2 key bearish confirmations with the third pending confirmation, however with the 21 week moving average sloping downwards and with the three other charts above already having breached the diagonal resistance line, it is highly probable that the XMI will follow suit and breach its diagonal support line (see Chart 4 Below).
As you can see all charts are strongly suggesting that we have started to turn into bearish trend and all have an heir of a double top pattern. To be clear, this is using the Dow Theory approach which historically has been very effective at getting us on the right side of probability but there are no guarantees, there are times the Dow Theory has been completely wrong. Given that three of the charts are in complete agreement with the fourth looking liking to confirm a similar bearish path, probability strongly in the favour of the bears. For those who appreciate this theory they would now start to make some changes to their portfolios to protect themselves from a drawdown event, as noted in the introduction protection from drawdown events is where The Dow Theory really shines.
The Halloween Effect might fool us all
The Halloween effect on the markets is based on the historical tendency for the stock market to perform better between Halloween Oct and May Day (the "winter" months) than in the other six months of the year ("summer" months). It closely related to the oft-repeated advice to sell in May and go away. In particular the months of Oct – Dec are some of the best return months impacted by the Halloween effect. I will follow up with a chart in the comments that illustrate the % return of the Halloween effect versus the summer months.
In the past the Dow Theory and other market indicators have provided confirmation of a bear trend and the market has made higher highs thereafter only to be thrown over into a longer bear market many months later confirming the original bear trend thesis. The point being is that it is probable we are going to see some impact from the Halloween Effect and this could in fact press prices higher in the short term, and in some cases we can even make higher highs. We need to be extremely cautious if we make reasonable progress during the Halloween Effect period, perhaps this could be seen as an opportunity to take some profits and de-risk some of your portfolio.
I have covered the XMI, DJT, XMI and DJI charts in detail previously on Tradingview and here. Please review them if you would like to get more familiar with their components and historical performance.
As always folks, stay nimble in this market and reduce risk where possible
PUKA
