st April 1 , 2015 Dow Theory for the 21st Century Schannep Timing Indicator COMPOSITE Indicator Charting a Course of Caution Dow Jones: 17,776.12 S&P 500: 2,067.88 OVERVIEW: There are many stock market and economic indicators ‘out NYSE: 11,062.79 there’, and we can’t follow them all. But every so often we see something that causes us to take a look. Recently a couple of lesser known, or followed, indicators have given us pause in our bullishness. A MarketWatch column by Mark Hulbert about an indicator described by Norman Fosback in his 1976 ‘classic’ Stock Market Logic is intriguing. In years prior to those shown in the chart below, Fosback states that from 1942 to 1975, the "tops of 1946, '56, '59, '61, '66, '68, and '73 were all accompanied or preceded by turns in margin debt". All but 1959 were major bull market tops, as you can see at the Historic Record on our website. The concept illustrated is that ‘sophisticated’ investors aggressively use margin in bull markets, but pull in their horns when stocks start going down. Fosback further stated that when the trend is down, there is a 59% chance a bear market is in progress (41% a bull market is in progress) - not good odds. That implies the bull market topped out earlier this last month on March 2nd at 18,288.63! How’s that for a cloudy outlook? On the other hand, when margin debt is rising there is an 85% probability that a bull market is in progress – as has been the case since 2011, until now. For more information, contact [email protected]. All logos, trademarks, and content used in this newsletter are registered trademarks and/or copyright of their respective companies and owners. 1 st April 1 , 2015 While the first month of margin debt below its 12 month moving average is not a leading indicator, a longer-term chart shows that margin debt’s first dropping/contracting was simultaneous with the 1987 bear market’s start. It led the 2011 bear market by 1 month, led 2000 and 2015(?) by 6 months, and led 2007 by 4 months. Even though the 1987 bear market decline was 36% and was 17% in the 2011 bear market, neither were followed by a recession, just as we are not expecting a recession in 2015. Still the bear markets occurred. We don’t mean to overwhelm you with charts but... as they say, a picture is worth a thousand words. The next chart is from a 3/18/15 article in MarketWatch entitled “Forget rates! Weak earnings, wobbly economy signal a correction”. While the chart doesn’t reflect a precipitous drop in real Gross Domestic Product (GDP) growth at this time, the magic 1½% is not that far away. If that were to occur, this current cloud over the market would indeed be turning dark. Visually these charts make a compelling point, and if their past record translates to the future, we may have a problem. Thus, the title of this letter indicating a course of caution. For more information, contact [email protected]. All logos, trademarks, and content used in this newsletter are registered trademarks and/or copyright of their respective companies and owners. 2 st April 1 , 2015 The current rate of US Profits deterioration is clearly associated with recession The next chart, which we first saw in an article by Cris Sheridan on FinancialSense.com shows several indicators encompassed in one chart. As with the one above, it takes some study. The gist is that Relative Strength Index (RSI shown at the top of the chart) has been weakening in 2014-15 while the market was rising, just as it did before the 2000 and 2007 market tops. According to StockCharts.com “Developed by J. Welles Wilder, the Relative Strength Index is a momentum oscillator that measures the speed and change of price movements. RSI oscillates between zero and 100. Traditionally, and according to Wilder, RSI is considered overbought when above 70 and oversold when below 30”. It has been above 70 for the last 15 months while the market rose, but now both may be changing. In addition, something named MACD (Moving Average Convergence Divergence) is close to a ‘crossover’ Sell signal (shown at the bottom of the chart). If you are not familiar with this indicator you might read about it at Investopedia. I know this is rather complex, but in short, Wikipedia describes it as “a trading indicator used in technical analysis of stock prices, created by Gerald Appel in the late 1970s. It is supposed to reveal changes in the strength, direction, momentum, and duration of a trend in a stock's price”. Finally, there is a moving average line which would be the last to turn down and be violated by the S&P500 index depicted in the chart. The first indicator, relative strength is flashing a caution sign; the others are flirting with one. For more information, contact [email protected]. All logos, trademarks, and content used in this newsletter are registered trademarks and/or copyright of their respective companies and owners. 3 st April 1 , 2015 Note that the recent level of the 12-month rising moving average (shown in blue) is just above the 1992.67 level that would generate a Sell signal under the Dow Theory (shown next), adding to its significance. The DOW THEORY for the 21st Century: This, the first of our more traditional indicators, is still in a Buy BULLISH mode with an average entry level of 15,548 from the July 18th, 2013 signal BUT the divergence between the Transports and the Industrials is a caution sign. That being the case, we have turned on the YELLOW light until either the S&P500 drops below January low of 1992.67, in which case a Sell signal would be given and the light turn to RED, OR the Transports rise above their all-time high from December of 9217.44 which would signal ‘in the clear’ and the signal would be returned to GREEN. That divergence is shown in graphic form below (another chart!): For more information, contact [email protected]. All logos, trademarks, and content used in this newsletter are registered trademarks and/or copyright of their respective companies and owners. 4 st April 1 , 2015 To summarize the status of the Dow Theory: New lows were NOT made by the S&P500 for a Sell signal and new highs were NOT made by the Transports for an ‘in the clear’, so the market is betwixt and between until one of those occur. The magic numbers are 1992.67 (a -3.6% decline from here) on the S&P for a Sell signal or 9217.44 (a 5.6% gain from here) on the Transports for an UP market: Dow Industrials S&P500 Index Dow Transports Step Market Highs 12/26/14 18,053.71 12/29/14 2,090.57 12/29/14 9,217.44 ≥3% Setback on 17,320.71 1,992.67 8,655.94 #1 1/15/15 1/15/15 1/15/15 two indices (-4.1%) (-4.7%) (-6.1%) Bounce ≥3% on at 17,813.98 2,063.15 9,143.52 #2 1/22 1/22 1/22 least one index (+2.8%) (+3.5%) (+5.6%) Break-down on 1/28 17,191.37 NOT! 1/30 8,649.32 #3 S&P plus one OR 2/20 2/13 Break-up on ALL 18,140.44 2,096.99 NOT! The Original DOW THEORY: Is in a somewhat similar status. New highs would be ‘in the clear’, while violating the January 31st lows on the Dow Industrials of 17,164.95 and of the Transports 8649.32 would be a Sell signal. Schannep TIMING ↓INDICATOR: This indicator continues to remain in a BULLISH mode (GREEN) with an average entry level of 11,746 from the August-October of 2011 Buy signals. For the moment, the Momentum is neutral while the Monetary portion continues Favorable, so no near-term change is in sight. The COMPOSITE Timing Indicator: No change here. Until and unless this Divergence resolves itself negatively, this Indicator remains in a BULLISH mode (GREEN), as it has since July 18, 2013, for an average entry level at 13,647.52. Should the Dow Theory give a sell, then this Indicator would drop from 100% invested to 50%. For more information, contact [email protected]. All logos, trademarks, and content used in this newsletter are registered trademarks and/or copyright of their respective companies and owners. 5 st April 1 , 2015 This might be a good time to remind our Subscribers that these Indicators are for the U.S. markets and that foreign markets might or might not follow suit. Also the percentages relate to our equity market portion which may be different if one has a total/balanced portfolio. → The BOTTOM LINE: IF a Dow Theory Sell comes about, then obviously we can forget for now about the ‘targets’ we have previously suggested. The bull market rose 71.6% and got to within 1.4% of our longstanding target of 18,550, the midpoint of Bull market advances over the last 100+ years. If the Sell signal comes, we would drop down to 50% invested and expect a short/normal bear market dropping in excess of 16% on both the Dow Industrials and S&P500 to qualify as a bona-fide bear market by our definition. Such a drop will not necessarily occur but the average drop after a Dow Theory Sell signal has been another 12.8% loss over the following 5.8 months (page 29 of my book Dow Theory for the 21st Century).