Tom Dorsey, founder of Dorsey Wright & Associates, was recently interviewed by Steve Forbes.
Point and Figure
We get asked — often — “how can you be so sure about these charts? Look at what the market did yesterday! Are you sure we’re doing the right thing?”
Now, one of our favorite movies is “My Cousin Vinny” And when we hear these questions, it sounds a lot like the dialogue between Vinny (Joe Pesce) and Mona Lisa Vito (Marisa Tomei):
Vinny: How can you be so sure?
Mona Lisa: If you will look in the manual, you will see that this particular model faucet requires a range of 10-16 foot pounds of torque. I routinely twist the maximum allowable torquage.
One of “the indicators” we employ is a relative strength measurement of the S&P 500 vs the bond market. Essentially, what this measurement tells us is, “is it better to be in stocks — OR are we better off in bonds?”
Here’s a picture of that chart, courtesy of our friends at Dorsey Wright:
So, what the heck does this mean?
Buy signals on this chart indicate it’s time to over-weight stocks instead of bonds.
And Sell signals indicate it’s time to over-weight bonds, instead of stocks.
This chart gave a sell signal in November 2000.
Then it gave a buy signal (over weight stocks) in summer 2003
It then gave a sell signal in July 2008 (time to under-weight stocks)
The chart then gave a buy signal in June 2009.
It’s been on that buy signal ever since.
Now, this is not the ONLY indicator we use. It’s one of several indicators. There will be times when this chart turns from a column of X’s into a column of O’s. That only tells us that stocks are weak, sloppy, the market is messy — and our phone is going to start to ring. That is OK.
So when we get days like yesterday (China down 7%, the US markets down a lot) it’s GREAT to have these indicators to fall back on. It beats relying on the knuckleheads on CNBC, or the articles on Marketwatch. Headlines on the Marketwatch website yesterday included phrases like “big losses” and “bear market” and “brace for big selloffs.”
Your New Years Resolution should be to turn off/tune out that noise. It will feed on your emotions and trick you into making a bad decision.
We have two quick updates on the S&P 500 and NASDAQ Composite indices today. Both are sending encouraging signals on their point and figure charts. They seem to be setting up for one of two potential patterns: the bullish catapult or the shakeout. Both the bullish catapult and shakeout are very bullish patterns.
Of course, we don’t know if these patterns will come to fruition, but they are something we’ll be monitoring closely in the coming weeks. A key with point and figure is to not anticipate signals or indicators, so while we are encouraged by these developments, things can change. Luckily, point and figure charts let us know what is happening in real time, as things pertain to the markets. We’ll be ready to adapt when the charts change.
Check out the point and figure charts of the S&P 500 and NASDAQ below for details. As always, our point and figure charts are provided by our friends at Dorsey Wright and Associates.
Last week, it was announced Apple will be added to the Dow Jones Industrial Average on March 19th. Since the Dow Jones holds just 30 stocks, one has to go. AT&T is being dropped on that day.
There is no “magic formula” for how a company gets added to the Dow Jones. It’s put together by committee at publishing company McGraw-Hill, since they own the Dow Jones name these days. That alone should make everyone cringe.
But here are the two big issues I have with the Dow Jones, with a tip of the hat to Barry Ritholtz:
First, it is the Dow Jones INDUSTRIAL Average. We don’t have much in “industrial” any more in the US. When Charles Dow was not creating point and figure charts in the 1890’s, he assembled this index to get a “pulse” of how the US economy was doing.
Over the past few decades, the Dow has “morphed” to include service and technology companies. Not very industrial.
Next, the Dow Jones is a price-weighted index. Meaning, the higher-priced stocks have a bigger impact than lesser-priced stocks.
The highest PRICED stock in the Dow (Visa), has nearly a 10% impact on the move each day. Goldman Sachs has nearly a 7% impact on the Dow.
So, when the US dollar or interest rates move up or down, Goldman Sachs and Visa (and other financial companies – JP Morgan, Travelers, American Express) will have a big impact on how the Dow moves (like this morning).
At the other end (the lower priced names), General Electric, one of the only companies with a true ‘industrial’ component, has a measly 1% impact on the Dow.
It just doesn’t seem right any longer. We wonder how relevant the Dow Jones Industrial Average is in 2015.
Here’s where it gets even goofier:
Goldman Sachs may have a higher stock price, but the market capitalization is $84 billion. General Electric, with a much lower stock price (and thus, a MUCH lower impact), has a market capitalization of $257 billion. Why should that be?
The Crude Oil chart over the past six months (since August 2014) has been in a free fall. The question now, is the crude oil chart merely glancing off the third floor awning (on the way to a splat on the sidewalk)? Or is crude oil forming a base that might become a new floor?
This point and figure chart is provided courtesy of Dorsey Wright & Associates.
Is the Crude Oil chart compelling, actionable, or objectionable?
In our view, here are some positives:
1. The crude oil chart appears to have (temporarily) stopped moving down.
2. The current location is in the middle of the ten-week trading band.
3. If crude oil can remain above $49, this would indicate rising bottoms. This is a sign supply (selling) is drying up.
4. The oversold condition has been worked off.
5. A move up to $54 would form a spread triple top.
And, in our view, here are some negatives:
1. Crude Oil remains in a negative trend. Bad things happen in negative trends.
2. Resistance for the crude oil chart is in the $70’s, FAR above the current price.
3. The asset group has negative relative strength versus the market.
4. Crude Oil (and commodities in general) is not a favored investment class.
Our Analysis (but not a recommendation!)
Gamblers line up: there is a TON of risk at the current time in crude oil. A rise in the price from here would be a source for speculation. A fall in the price of crude oil from here would be a resumption of the downward trend which is already solidly in place. Make no mistake, this chart is currently in a severe downward trend, this is NOT a place for conservative investors!
It is possible to make money in charts like this crude oil chart. But the odds are stacked against us currently. Risk!
A better outcome for this crude oil chart would be to see continued basing around these levels. Over time, simply “treading in place” and creating more column changes (more columns of X’s and O’s) would drag the overhead resistance line down much closer to the current price. What that does is put the price closer to moving into a positive trend. In a positive trend, we have improved chances for better (positive) outcomes.
Here at Mullooly Asset Management we use a form of technical analysis called point and figure charting to manage investments. In point and figure, one of the main purposes the chart has it to help us identify trends. Whether we’re looking at a stock, index, mutual fund, ETF or commodity, the chart will show us its trend. On this week’s podcast, Tom and Brendan discuss how bad things happen in negative trends and relate that to the current weakness of commodities.
To begin 2015, many market headlines have been about commodities crashing. It seems like you can’t check any market related site without seeing a new post on crude oil. The commodity space is ripe with examples that embody the statement: bad things happen in negative trends.
So what do we mean by a negative trend? On point and figure charts we use two main trend lines: the bullish support line and the bearish resistance line. You can see them clearly identified in the chart below. These trend lines can stay in force for months or years at a time. When something breaks its bullish support line, it enters a negative trend. This is a huge deal!
The chart below shows crude oil. You can see that near the end of July/early August it broke through its bullish support line around $100 a barrel. The chart tells the story since then and we’re seeing prices in the $45 a barrel range today.
As you can see on the crude oil chart, bad things have certainly occurred in its negative trend. The examples don’t stop there though! Other commodities experiencing big draw downs in negative trends include copper, gold, and silver:
- Copper broke its support line at $3.20 in March 2014. The price has dropped over 20% since then, and today it’s trading around $2.64.
- Gold has been in a negative trend since February 2013 when it was $1600 an ounce. Gold is currently around $1230 an ounce.
- Silver entered a negative trend in September 2011 at $37 an ounce. Today it’s around $17 an ounce.
The headlines will have you believe that the commodity crash is a new phenomenon, but as you can see, many commodities have been in negative trends for a considerable time. Bloggers and journalists love to speculate about the reason why things like this are happening to commodities. They make for interesting articles, but the truth of the matter is that price matters most. We might find out weeks, months, or years from now what the real story behind the move in crude oil has been. That’ll make a fascinating book, but it won’t bring back the money investors have lost over the last few months.
We can avoid situations like the current one in commodities by watching the charts. When something enters a negative trend, it’s a big deal and needs to be handled accordingly. We’re not in the business of fighting trends here at Mullooly Asset Management. When the charts change, we change with them.