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VIDEOWhat the Dow Can Tell Us About Past and Present Markets, Part 3
It's not necessary to sound alarms right now, but the outlook for US equity markets remains cautious.
Long-Term Chart of the Dow Jones Industrials (1921-2010)
Some quick notes about this chart:
It’s monthly, semi-log, and shows the Dow since 1921.
I use a 72-month moving average with two envelope lines based on the moving average (one line at 90% above the MA and the other at 30% below the MA).
The long-term uptrend line begins with the bottom in 1932, connects to a corrective low in 1982, and extends out from there.
At the bottom, I show the RSI for the Dow, using the following settings: 18-month period; oversold at 30; and overbought at 85.Takeaways From This Chart
First, there were only three times in history when the RSI (using those specific settings) read oversold: the 1932 low, the 1974 low, and the 2008-2009 low. That really puts into context the historical significance of the recent bear market.
The first two times the RSI read oversold, a rally developed shortly afterward that yielded returns similar to those seen in 2009. However, in each of those two cases, once the peak of the initial thrust was made, a significant correction occurred that took the Dow back down to either the lower moving average envelope (in 1942) or to the long-term uptrend (in 1982). It should be noted that in each case, the correction ended up creating a higher low -- but only after giving back 60% of the gains from the initial up move.
Second, there were only four times in history in which the lower moving average envelope (which comes in at 30% below the MA) was touched. The first was in 1929-1930. As you can see (or already know), that wasn’t an effective buy signal. However, the other times -- in 1942, 1974, and 2008-2009 -- the lower MA envelope was touched would have been excellent opportunities to get long (or cover shorts).
Third, the upper envelope -- which is set at 90% above the moving average -- has only been touched twice in history. In each instance, it occurred right before the most famous market crashes in history -- those of 1929 and 1987.
You may think I missed the late 1990s. Not so. During that period, the upper MA envelope was approached but not touched. Selling long or short could have been costly during that time period. Time would have proved a speculator correct, but who has that kind of time (and staying power)? So, in this case, the approach (but not touch) of the upper envelope was a warning sign of something off in the distance. But alarms and sirens weren’t sounding.
Where Are We Now?
After recovering from the historic low in March 2009, the Dow is sitting at 10,782.95 -- just below the 72-month moving average at 10,956.16.
If the initial thrust is over (big assumption -- remember the head-fake in February?), then a healthy corrective move lower (which will result in a higher low) should be expected.
Daily Chart of the Dow Jones Industrials (October 2008-Present)
A break and close below 10,074 (let’s call it 10,000) will open up the door to more downside -- possibly as much as a 61.8% retracement of the ’09-’10 rally. That would take the Dow down to 8,272.11. That level corresponds closely with previous turning points.
Such a decline, if it happens, would be in line with the corrective moves following the first wave up after historical lows were made in 1932 and 1974. The results of this chart study compare very favorably to another research study I completed earlier this year. My findings were posted on March 22 and March 30 (see Part 1 and Part 2 of this series).
Please note that I’m not sounding alarms at this time. I’m simply providing context. My outlook does remain cautious for US equity markets. Risk management and money management should be high priorities.
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