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Answering 3 questions about Dow Jones Industrial Average

I did a lunch time talk ‘Market Primer’ at IG Asia earlier today. This is a regular/recurring event that runs once a month. There is also a monthly forex lunch time talk as well. You can find details here, register your attendance through this link.

I cannot emphasise how important these sessions are to myself – they force me to confront the market objectively regardless of my own bias. It is also a kind of enforced exercise – if I did not have these sessions, I doubt I would be doing these analyses regularly. So here I would like to share 3 important questions that were brought up and how I see them.

 

3 questions about Dow Jones Industrial Average

  1. Is there an US presidential election effect?
  2. Can I short it?
  3. Will DJIA go higher?

It is highly important to satisfy ourselves with a qualified answer in light of the cognitive dissonance that is going on like why is the US stock market so bullish?. That with the kind of negativity from US data as well as crash in many other global stock indices, how come the Dow is back to nearly all time high?

In addition, I have covered over time, why stock indices are due for a big correction in stories like these:

 

Is there an election effect?

This question came up late last year and early this year. In my opinion, there is a long answer and a short one. My short answer is ‘No’ but the long one is ‘it depends on who you are and what you do’.

If I answered yes, it is highly likely some over-enthused individual will catch every dip with both hands. We know how that turned out in January with Hang Seng Index and Straits Times Index falling sharply by over 30% early in January. Buying an ‘election effect’ on Monday 04 January is a widow-maker for sure. Applies to most other markets. The Hang Seng Index for example remains negative YTD despite a big rally from February low.

Come US stockmarket, we cannot deny there could be some truth. Let’s take a look at this chart of the Dow in 2000. 2000 was an election year as well. George W Bush was elected POTUS on 07 November 2000. If you look at the concurrent crash in NASDAQ which fell nearly 60% by end 2000, Dow was sweet as roses. Go all in to buy? Not so fast. Despite staying resilient mostly, there was still some great volatility there with nearly 15% corrections even as late as October. If you are ready for a 15-20% correction in your portfolio value, it looks great. If you are highly leveraged with no room for mistakes, good luck.

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Dow Jones Industrial Average Y2K

 

Can I short it?

This is clearly a ‘No’. The US stockmarket remains outperformer against all others. The right approach is to short losers (like China A50, Nikkei 225), buy winners (S&P 500, DJIA). The US is clearly a winner. Besides whatever technique you use, this huge rally means the US index is up trend by most short term indicators. That means that one would be shorting into a lot of supports, short-term indicators like moving averages for example.

 

Will DJIA go higher?

This is difficult to answer. My own sarcastic answer is ‘Yes’, the Dow will go to 180,000 when the Federal Reserve runs QEinfinity, print 10 USD for every 1 USD in existence both physically and electronically today. Short of that, in my opinion, my honest answer is ‘No’ the US economy is NOT doing well and the Dow should not go higher.

One of the charts I look at is this overlay of DJIA with IWM. IWM is an ETF of Russell 2000 which is an index for small cap stocks. Because the index ticker is missing, I have no choice but to use the ETF instead. What I see here is clearly a sign of divergence and weakness.

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DJIA – IWM divergence; IWM is underperforming

In most economies, small enterprises make up a larger portion of the real economy. They do more local business, hire larger percentage of the local workforce (up to 70%), contribute more to the community. These are the companies that make up the Russell 2000 index. Those in the Dow are different. They have a more global footprint, outsource their manufacturing overseas and receive overseas revenue. Just think about Apple for example.

It is entirely possible for DJIA to outperform and yet for the US economy to do poorly, which is what I see here where IWM is clearly diverging.

Zoom out of this chart to a 2010- present time frame and it is even clearer.

IWM

IWM clearly descending

In a healthy economy, IWM should be outperforming, like the first half of 2011 and then again from 2013 – 2015. This is no longer true, IWM is no longer performing as well and if we compare peak to peak in terms of stock performance, IWM is clearly descending. This does not bode well for DJIA. What remains is a matter of time frame, and if the Fed will run some more stimulus programs that will just prop up large caps some more.

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Director, TerraSeeds Market Technician Pte Ltd. Trader, investor. @sohtionghum was picked ‘Top 70 Forex Twitter in 2015’. Operates multiple strategies.

“Dear reader, I do not have a financial license to give advice. I do not know you the reader. Your financial objective and risk tolerance may be different from mine. I am not responsible for any consequence of your action.

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