Peak Dow for Stocks?

Well, the stock market’s having a well-deserved break after motoring ahead recklessly for the past few months. The bulls will take comfort in this. They’ll say a pull-back should not surprise after such a strong run…that it’s ‘healthy’.

Indeed it is. And if you look at a short term chart like the one below of the Dow Jones Industrials index, you couldn’t help but agree. Since bottoming in mid-November 2012 at around 12,500, the Dow has added nearly 1,400 points. That’s an 11% gain in a little over two months. Momentum indicators such as the RSI (top of the chart) and MACD (bottom of the chart) are in ‘overbought’ territory and the index is well above the 200-day moving average (red line).

So time for a pullback, right?

Source: StockCharts
Yep. A good ole pull-back before we’re off to the races again…

But hang on a minute. Let’s change the context with the same chart in a different timeframe. (Don’t you love charts, you can slice them up any way you want to get your point across!) So in that spirit here’s a chart of the Dow Jones Industrial Index over 10 years. Same index, different time frame.

And to make it interesting, it’s a weekly, rather than a daily chart. That is, the data points are weekly rather than daily…which helps to reduce some of the ‘noise’ that comes with long term daily charts.

And here’s what you get…

Source: StockCharts
As you can see, the Dow Jones is bumping up against the highs of 2007. Does this mean anything? Well, it’s a psychological barrier, that’s for sure. Buying stocks at Dow 14,000 in 2007 didn’t turn out so well.

And while we’re not sure that many traders actually remember back to 2007, there must be a few out there who can recall events further back than a few months.

At the very least you can expect some back and forth around this important psychological level. We’re not making any predictions as to which way it will eventually break. But you can be pretty sure that if and when it does punch through that level, it should surge higher again from purely a momentum perspective.

But if it can’t manage to do so…the formation of a ‘double-top’ portends some pretty nasty action ahead.

We’d prefer to sit on the sidelines to watch the outcome. We want no part in the craziness. Economic stagnation and a rising stock market make for strange bedfellows. This weirdness makes us recall a statement made by the world’s pre-eminent physicist of the 18th century, Isaac Newton, after he lost his shirt in the South Sea Bubble:

‘I can calculate the motions of the heavenly bodies, but not the madness of people’

We concur. But what makes this market even more treacherous is that there is no discernible bubble in stock prices based on traditional methods like price-to-earnings ratios. The bubble is in the system itself…in the creation of credit…

It is this vast creation of credit which bubbles to the surface, finding an outlet in various asset markets…junk bonds and other forms of corporate debt, government bonds, blue chip stocks. But little of it finds its way into productive investment. Easy money tends to find an easy use. Genuine investment and productive endeavour are hard.

Greg Canavan
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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