There are only a few well-known signals which I consider reliable. One of them is the Dow Theory. According to it, or at least to some interpretations of it, the bull market cycle almost ended this Friday.

This time I am adding something new. I recorded myself while doing some of the analysis:

Different people interpret the Dow Theory differently. My personal favorite is Jack Schannep’s interpretation. I was introduced to it by his excellent Dow Theory for the 21st Century book. What really hit home with me, is that his approach is fully-quantified. The book also covers 60 years of history and provides detailed data on entry, exit, gains, etc. All in all, one of the best I have seen. I have been monitoring some of Schannep’s indicators in real life for quite a while now. The signals are rare, but for example take a look at my old blog posts around the European crisis of 2011.

So what happened on Friday? Well, the indexes closed at levels very close to signal the end of the bull market. First, let’s take a look at the S&P 500. The R code first:

require(quantmod)
require(plotly)

pretty.plot = function(t, name, short.name, level) {
  df = data.frame(Date=index((t)), Close=as.numeric(t), row.names = NULL)
  hovertext = paste0("Date:  <b>", df$Date, "</b><br>", short.name, ":  <b>", trunc(df$Close), "</b><br>")
  p = plot_ly(data=df, x = ~Date, y = ~Close, mode="line")
  p = layout(p, title = name)
  p = add_lines(p, y = ~Close, line = list(color = "#00526d", width = 4), hoverinfo = "text", text = hovertext)
  p = add_trace(p, x = df[,'Date'], y = rep(level, NROW(df)), showlegend = FALSE, mode='line', hoverinfo = "none", line=list(width=0.5))
  p
}

gspc = getSymbols("^GSPC", from="1900-01-01", auto.assign=F)
pretty.plot(Ad(gspc)["2017-09/"], "S&P 500", "S&P 500", min(Ad(gspc)["2018"])) 

The code uses plotly for charting. I got inspired by this link.

This results in:

 
The critical level to watch is $2,581. The Friday close was $2,588. Still holding.

Next comes the Dow Jones Industrial Average (DJI):

 
The important level here was $23,860. It was breached on Friday, the close was $23,533.

So it comes down to the Dow Jones Transportation Average (DJT):

 
The important level here was $10,136. Friday’s close was higher – $10,163. Still holding.

What does all this mean? If you are interested in history around similar events – check out the book. What it means to me is that the party can be over anytime now. Even a small down day will squeeze out a confirmation from the S&P 500 or from the DJT, which combined with the signal from the DJI will put us in what I call the no man’s land. No bull, no bear – we will be waiting for further confirmation.

To make things bleaker, the Fed is tightening.

On the bright side, we haven’t reached a bear market definition yet. Here again I am a Schannep’s follower – a bear market is at least a 16% correction. On the DJI, the market currently measures an 11% correction. 16% is around $22,358 more than a 1,000 points lower. The skeptics will also point out that we haven’t crossed the 200-day moving average yet.

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