Everyone is now into Dow Theory

One tenant of Dow Theory is that stock market averages must confirm each other and so we need the Dow Transports to confirm a new high or low posted by the Dow Industrials. Keep in mind that Dow did not state a time period for the confirmation to occur. According the Wikipedia, Charles H. Dow stated a bull market in industrials could not occur unless the railway average rallied as well, usually first. According to this logic, if manufacturers' profits are rising, it follows that they are producing more. If they produce more, then they have to ship more goods to consumers. Hence, if an investor is looking for signs of health in manufacturers, he or she should look at the performance of the companies that ship the output of them to market, the railroads. The two averages should be moving in the same direction. When the performance of the averages diverge it is a warning that change is in the air.

Today most of us know – thanks to the business media that so far this year the Transports have not followed the Industrials on to new 52-week highs. Now back in Dow’s time the Transports did not contain truckers and airline stocks and today it is not unusual to get performance divergence between the rails, the truckers and the airlines. A look at two important railroads make me wonder what all the fuss is about – both are still in linear up trends. Keep an eye on FDX and UPS to see if they can recover back to their 40 week MAs over the next several weeks. If that does not occur then I may have some concern

Francis Horodelski is a bear

One of my favourite BNN personalities is Frances Horodelski who according to BNN has been following markets for over 30 years, including 25 years with two of Canada's largest investment dealers. Her career has spanned research, portfolio advice, investment banking and international strategy. She also holds the designation of Chartered Financial Analyst.

Anyway aside from all that I just like her common sense delivery – but I think the bearish guests have seduced her into the bearish camp. I do know Francis respects technical analysis and so I am posting two important charts that clearly deliver a bullish spin.

The first chart is the weekly iShares TLT which is a measure of fear – the higher the price, the greater the fear and so we need to see the TLT to roll over to confirm a shift to equities. Our chart displays a bearish rising wedge or diagonal triangle. The rising wedge is rare and very deadly – this is the only pattern that when identified I will sell into. 

The second chart needs little explanation – the NYSE advance / decline line which is a measure the breadth of a stock market advance or decline. The AD line tracks the net difference between advancing and declining issues. This study has been around for generations and like point & figure is ignored by the younger technical analysts who prefer the flashy MACD and Stochastic lines. However this little used study usually leads the price and so when the A/D line beaks to all time highs – I get impressed

 

The next big thing

The next big thing means that when discovered early a patient long term investor could out perform the broader stock indices. Some past next big things were technology 1980 to 2000 and commodities 2001 to 2011.

Aerospace is a next big thing contender with U.S. PowerShares Aerospace & Defense (PPA), Honeywell International Inc. (HON) and General Electric Company (GE) pushing to new 52-week highs and perhaps with some – all time highs. Some small Canadian aerospace related names, Heroux-Devtek Inc. (HRX) and Magellan Aerospace Corporation (MAL) were also printing new 52-week highs. The Canadian laggards remain CAE and Bombardier. Aerospace is currently under-owned and devoid of investment sheep. I need to re-visit this group in a few weeks. 

Another “next big thing” contender is the lumber space with names like Acadian Timber Corp. ADN Ainsworth Lumber Co. Ltd. ANS, International Forest Products Limited (IFP.A), West Fraser Timber Co. Ltd. (WFT), Canfor Corporation (CFP), Norbord Inc. (NBD), Weyerhaeuser Co. (WY) and Rayonier Inc. (RYN) all printing recent new 52-week highs.

I did a Google on lumber seasonality and found on a site called Equity Clock and I quote “Lumber Futures Continuous Contract Seasonality, Analysis has revealed that with a buy date of October 23 and a sell date of November 19, investors have benefited from a total return of 45.44% over the last 10 years. This scenario has shown positive results in 8 of those periods”.

If you do some Bill Clinton arithmetic you find that a 10 year 45.44% total return works out to only a 3.78% annualized return – clearly not worth all the trading work . We know lumber prices have declined 70% from a May 2004 peak to a March 2009 low and then subsequently doubled in price from a deeply over-sold condition. The 2009 low of Weyerhaeuser seems to be positioned where the gold miners were back in mid 2001.

Swing Trading is not investing

This is a clip from a Donald Vialoux blog post September 5, 2012

Quote: A "buy-and-hold" investment strategy is dead. It has been dead for the past ten years. Indeed, it is expected to be dead for another six years. The solution is to use a swing-trade strategy based on a combination of technical, fundamental and seasonal analysis. End Quote.

Don stated the Horizons Seasonal Rotation ETF (HAC) to be a swing-trade strategy.

According to investopedia.com., swing-trading is style of trading that attempts to capture gains in a stock within one to four days. Swing traders use technical analysis to look for stocks with short-term price momentum. These traders aren't interested in the fundamental or intrinsic value of stocks, but rather in their price trends and patterns. Respected technical authors Martin Pring and John Murphy use the term swing-charting to teach the skills of short term trading. A quote from the back cover of Pring’s publication (Technician's Guide to Day and Swing Trading) states “Professional day and swing traders have begun to realize that the disciplines of technical analysis can dramatically increase their trading accuracy and end-of-day profits.”

Buy-and-hold is a long term investment term who’s success depends on what you buy-and-hold. You can buy and hold the broader stock indices and you can engage in stock picking. Buy and hold on the Dow Industrials (through one of the many ETFs) has generated the following annualized returns 30-year + 9.35%, 20-year + 7.24% and 10-year + 4.27%. All returns exclude the annual dividend income of about 2%.

Since inception of November 19, 2009 the swing-trade HAC has generated an annualized return of 8.28 % and the buy-and-hold Dow (DIA) has generated 9.4% - excluding the dividend return of over 2%. Good stock picking does even better with a buy-and-hold on BCE since November 19, 2009 being +19.4%, CNR +17.3% and TD a + 7.2% - all excluding dividend income. Buy-and-hold investors also were big winners in the consumer and REIT sectors over the same time period

One could argue that anything bought in November 19, 2009 would have made money so let us shorten the time frame and look at the current 52-week returns when the market conditions were “difficult”. The buy-and-hold Dow Industrials (DIA) returned +21% - excluding dividend income and the swing-trade HAC did +2.6%. I understand that many investors do not have the patience or the skills for buy-and-hold investing but clearly swing-trading is not the solution.

Larry Berman is still cautious

A clip from Larry’s blog post August 31, 2012

Quote:

TSX Likely to Slide Before Support Develops - The TSX appears to failing above the 200-day average as anticipated. A cooling in the energy and gold stocks are the main catalyst, but bank earnings, while tending to be better than expected (especially on the dividend front), had some weaker elements. They have also rallied in the past few months, so some natural post earnings profit taking is typical too. When added all up, the TSX is likely to slide a bit more next week before support is likely to develop. With all key sectors moving, and some likely rotation, it is tougher to determine where support is likely for the broader TSX. If the breakout is going to hold, we should not close back below about 11,700. Weaker than that would suggest no QE support from the Fed and ECB.

End Quote

Very good analysis from Larry and it is obvious he focusing on the negative data. When in doubt I always refer to a point & figure chart for clarity. A point & figure study has several advantages – the most important of which they are not popular with the younger analysts because they are thought to be “old school” – not flashy like the modern MACD and those other squiggly lines. Point & figure charts have a non linear time scale and can store a huge time frame and point & figure charts can display reliable trend reversal junctures – I never argue with a point & figure – the TSX Comp P&F displayed clearly displays a bullish reversal - don’t shoot the messenger.