The Dow Jones Industrial Average has long been the index most widely recognized as a representation of the equities markets. Speculators and unsophisticated investors will use the value of the Dow as a measure of market value, and invest accordingly. While the Dow is certainly an index that should be tracked and is important to follow, it is hardly the only measure of value in the equities markets. The fact that the Dow is not a consistent index as well (the underlying 30 stocks that comprise the Dow Jones Industrial Average have been changing since the turn of the 20th century, adjusting for non-performers, mergers, or companies that have filed for bankruptcy) makes understanding how to read the Dow all the more difficult. In the last 12 months, some interesting chart patterns have developed, and we believe that the Dow is in the process of establishing its next trend.
Since October of 2013, the Dow has yet to experience a 10% correction. In February of 2014 the index pulled back almost 6.6%, then 3.4% in April and 4.4% in August. At time of writing this article, the Dow has experienced a 3.3% drop in the last month.
The interesting thing about the February and August drops compared to the August drop is that while they occurred over similar time frames, the first 2 occurred in sudden drops, while the most recent drop has been a more staggered decline. Another insightful piece of data is how long it took for the Dow to reach its old value following the respective declines.
The Dow started 2014 at about 16,500, and by the beginning of February had fallen to 15,400. The Dow did not hit 16,500 again until April. Following the April decline, it took almost a month to get back to 16,500 again. In mid-July, the Dow had peaked at 17,138, then quickly dropped to 16,370 within 3 weeks. The old high of 17,138 was not reached again until the beginning of September.
At the time of writing this piece, the Dow has returned a lackluster 1.4% year-to-date in 2014. After each of the declines earlier this year, the Dow took anywhere from1-3 months to return to previous peaks. With that thought in mind, we have some short term thoughts on the Dow.
Once a short term bottom has been reached, there are logical 3 directions that the Dow could take: 1) the Dow could hit its short term bottom and rebound to the previous peak in an estimated 4-8 week time frame, 2) sellers could panic and deleverage causing more substantial losses and signal a coming bear market, or 3) The Dow could be establishing a sideways trading pattern. In no scenario do we see a 20,000 Dow coming any time soon. Essentially, the thought is that unless the Dow Jones sees some violent swings in the coming weeks, the index may very well have low single digit returns for the year.
While we are long-term bullish on the US economy, we have made it no secret that we think large-cap equities are overbought. The biggest concern that we see is that this may not be a short term downtrend that will be recovered within the quarter. Due to the nature of the declines in such a staggered fashion, this could be the unwinding of excess leverage in the equity markets, or traders who have been bullish since 2010 packing up their bags for the time being.
It is worth noting that we are in no way predicting the direction of the Dow Jones Industrial Average, and that a top or bottom will be impossible to recognize until after the fact. It is also worth noting that while we utilize technical data in managing money, our strategy and focus are more grounded in fundamentals. It is impossible to tell exactly what traders are thinking or how to time the markets precisely. Without doubt, we will be watching the Dow Jones, NASDAQ, S&P 500 and the Russell 2000 very closely in the coming months to track this correction, keeping an eye out for restabilization or the possible beginning of a longer-term bear market for equities.