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.

Stock Market - Black Monday (Aug 21, 2015)

Today's market action was very scary. Since last week to today's lows, markets decline over 10%. This decline wiped out more than ~$1.5 Trillion in wealth from the stock market.

If you had looked at the news today, it was horrific. There was live coverage on the decline even on channels like CNN. I have received several calls from investors trying to figure out if they should enter the market or not. And how are the proprietary models of Understand, Survive and Thrive, reading into this market.

I would like to start by saying that panicking will not help!!!

DJIA completed a head and shoulders pattern at the top, which was not noted in the financial media. This kind of development suggested that we should expect this head and shoulders pattern to play out. However, I did not expect a crash like scenario.

Now that we have seen the flash crash type of event, the big question is how should one proceed. Should we buy the dip or use the rally to sell-out of equities. In order to objectively analyze these two options, lets look at three Bull/Bear market indicators that we have used to great success.

1. Yield curve inversion: Historically, over the last 50 years no bear market has ensued without yield curve inversion (link). If that is the case, yield curve is not inverted yet and therefore, we should give benefit of doubt to the market
2. Proprietary Bull/Bear indicator, using optimum Bull/Bear criteria, is calculated on a monthly basis. As of last calculation at the end of July, it was registering 70%, which is above the threshold of 65%. Although the indicator will be recalculated on Aug 31, persistent market decline can result in us entering a bear market. This would mean that we have several months of lower prices ahead. The true result will come out on September 1st and therefore, no decision of exiting longs will be made till that time
3.  Another very important Bull market indicator is still bullish which uses Global Dow as the proxy of global stock markets. It would need September data to declare whether we have entered a bear market or not.

Therefore, next few days will be very crucial for the market. Since the yield curve has not inverted yet, the chances of entering a prolonged bear market are very slim. As a result, this should be a buying opportunity. If the market is to avoid entering a bear market based on proprietary indicators, it should rally hard over the next few days. From a geo-political standpoint, it would make sense for the market to stay up for till next year's election because there is no change in policy and Congress gridlock continues.

In conclusion, we should expect a sharp rally over the next few days. Otherwise, markets will enter a prolonged bear market, which yield curves inverting over the next few months.





 

Market Analysis & 8/4 Test

Friday saw a sharp decline in the markets, as expected from the IPM Model forecast, which stated that markets should continue to decline till next turn date. Markets topped in October, and started to decline while most of the people were expecting a rise into the elections. If market continues to decline over the next week, people will start attributing this decline to damage caused by Hurricane Sandy. However this might not be the case, in fact this decline might suggest that market is expecting a Obama Win in the elections (another blog post will be published).

Since one needs to analyze the market from a holistic perspective,  Market Matrix helps in analyzing the market in terms of Sentiment, Market Trend, Elliott Wave structure, Technical Indicators, and Leading Markets. Market Matrix takes on even more importance when taken in conjunction with the 8/4 Test. Currently, Market Matrix is neutral while 8/4 test is signaling a sell signal. This is very ominous development for the market.

8/4 Test is a unique method developed by Understand, Survive and Thrive, to determine when we have seen a significant trend change. Friday's market decline has brought the market very close to generating a Sell Signal. The 8/4 Test has perviously signalled larger trend changes. For example, a 8/4 Sell Signal was generated before following declines:

May 2010       SP500: 1164 ==> 1004     -     13.8%
May 2011       SP500: 1330 ==> 1264     -     5%
July 2011       SP500: 1326 ==> 1076     -     18.9%
Nov 2011       SP500: 1216 ==> 1160     -      4.6%
May 2012      SP500: 1365 ==> 1265     -      7.3%

Median Decline: 7.3 %, Average Decline = 9.9%
Prob (Decline) = 0.9

Expected Decline = 9.9 *.9 = 8.96%


8/4 Signal is composed for 4 steps:
1- Decline / Setup: This step involves initial decline to a proprietary Moving Average (8)
2- Test: Initial decline is followed by a rise to a faster proprietary Moving Average (4), but does not make a new high
3- Failure: Market starts a sharp decline
4- Breakdown: Market breaks below the M.A. (8)

We are currently at the fourth step. Once this step is completed (Decline below 1406), we can see sharp decline. Based on expected decline of 8.96%, market can decline to low 1300s. Please note that this is a statistical calculation, and will be refined with the latest IPM data)

Interesting Observation:
The market top was forecasted by the IPM Model even before the 8/4 Setup was initiated. Current 8/4 test suggests that the decline we are witnessing right now will be deeper then expected. Although we can see a brief rally within next 2 weeks (as per IPM update sent to subscribers), market will not start a bull market after elections have been completed. Instead we could see a lower low or a double bottom at the next IPM Turn date (will be sent to subscribers).

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