I’ve received a few e-mails asking if the decline into June, below the May lows, triggered a so-called “Dow theory sell signal.” The answer is no. From a Dow theory perspective, the advance out of the March 2009 low still remains intact. Dow theory does not give buy and sell signals. According to orthodox Dow theory, it is the price movements above and below previous secondary high and low points that serve to confirm primary trend changes. It is these primary trend changes that serve as a barometer, as such, for the future direction of the market. One of the most confusing points with Dow theory is the identification of secondary high and low points. I think the reason this question has come up is because of the violation of the minor lows that were made throughout the month of May. It is because these minor lows were not secondary low points that a trend change has not occurred.
Unfortunately, Dow theory itself does not offer a quantifiable means of identifying secondary high and low points. This comes primarily from studying the writings of our Dow theory founding fathers and then developing a feel, from experience, for identifying these levels based on experience. Now, with that said, I want to make it perfectly clear that Cycles and Dow theory are two completely different disciplines. However, in going back to the inception of the Dow Jones Industrial Average in 1896 I have found that secondary high and low points coincide with intermediate-term cycle highs a lows. Because cycles offer us a way to quantify intermediate-term cycle highs and lows, by understanding cycles and the structure and quantification that they offer, we then, by default, have an edge with our Dow theory work and our ability to identify secondary high and low points. So, when looking at the market it is a matter of what label we use to identify a particular price movement. But, the bottom line is the cycles work gives us a more tangible way of identifying and anticipating secondary high and low points in accordance with Dow theory. Because of this knowledge I can say that the violation of the May lows did not trigger a primary trend change in accordance with Dow theory. More detailed analysis and expectations, based on the combination of cycles and Dow theory, are covered at Cycles News and Views. The current Dow theory chart can be found below.
Now I want to look at the Shanghai Composite Index. Like the Dow Jones Industrial Average, this index peaked in late 2007. This index found its low in October 2008 and thus far, the top for the counter-trend rally occurred in August 2009, with a cyclical low occurring in July 2010. From that low the Shanghai attempted another rally, but once again fell short of the August 2009 high. Because the August high has not been bettered, the danger here is that we now have a failure in place. Until/unless the August 2009 high is bettered, this negative structural development serves as a warning. Given that the averages are so closely correlated these days, we must also look at this failure as a warning of what may be in store for other stock market averages around the world.
As the markets moved down into the 2009 lows, I explained to my subscribers that they were moving into a higher degree low, the 4-year cycle low. I also explained that this low would correspond with the phase I low in accordance with Dow theory. I explained that just as stocks and commodities came down together, they would go back up together as the rally separating phase I from phase II unfolded. I also said that the longer this rally lasts, the more dangerous it would become. What I meant by this was that the longer the rally lasts, the more convinced the public will become that the bear market has ended. Based on the historical relationships between bull and bear markets, the phasing of Dow theory and the historical valuations seen at secular bear market bottoms, the 2009 low was not THE bottom. Every indication is that the rallies seen in stocks and commodities since late 2008 and early 2009 are counter-trend rallies. These rallies have now gone on so long that almost no one sees them for what they are and the notion of a continuation of the bear market is indeed a hard concept for most to understand. In the meantime, this counter-trend advance in accordance with Dow theory still remains intact. More importantly, from a cyclical perspective this advance will remain intact until the historical DNA Markers that have been seen at every major top since 1896 are seen.
