Wednesday, January 6, 2016

Long Term View of Dow Jones Industrial - $DJIA

Markets continued their decline and are again poised for a down day with China closing early due to circuit breakers being activated for the day.

We have been talking about the stock market trend change since September 2015 in the following blog posts:
  1. New Year and the Stock Market
  2. Bonds Rally Analysis and Stocks
  3. Importance of objectivity in trend following
  4. Current Market - Bear Case Evaluation
  5. Investment Optimization Model (IOM) Performance - August 2015

At the same time we have been discussing markets via twitter on a more frequent basis. In this post, I would like to analyze the market from a long-term perspective. Chart below shows the performance of Dow Jones Industrial Average over the past 2 decades. 

Following are the key highlights evident from the above chart:

  1. US stock market remained in a sideways phase for over a decade
  2. US stock market broke above the resistance level in 2012. This break was more pronounced in SP500
  3. Rounding top/Head and Shoulders top formations took place at the two prior tops. And currently, it seems like a similar pattern is being formed
  4. There is a longer-term trend line which the market failed to break to the upside, and might have capped this bull-market
  5. Since the economy lags the stock market by ~6 months, we can start seeing the impact of lower oil prices through energy sector decline in the economy, starting in Q3'16
  6. If the market has really topped, we can expect ~7+ months of decline to correct last ~7 years of rally (if we are not in a secular bear market)
  7. Decline in earnings will result in higher P/E ratio. As a result, stock prices might come down to bring the P/E ratio to normal or lower valuations
  8. Many of the individuals components of $DJIA are tracing out individual Head and Shoulder patterns, which could mean that the market's components are broken
  9. Best case scenario for this correction would be to end before breaching below 2011 lows
  10. Worst case scenario would be a break below 2009 lows and formation of an expanded traingle pattern, similar to 1970s bear market but a larger scale
In short, current market decline should be looked at with caution. Until and unless the model confirms a bull market, we will not enter long. Algorithm has been long bonds for a while and went short on stocks on Jan 1st. Aggressive portfolio is long other assets based on proprietary asset allocation mechanism.

At UST we have now dealt with short-term trading based on IPM trading model and longer-term investment based on Investment Optimization Model. We will continue to share our insights with readers. For now be careful. We will go long, as soon as the model goes long.

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