Revisiting Dow Theory and Bank of Japan’s Shock and Awe

By the Curmudgeon with Victor Sperandeo


Was a Dow Theory Sell Signal Reversed on Oct 31st?


On Friday, Oct 31, 2014, the Dow Jones Industrial average closed at 17,390.52 -- a new record high.  That confirmed the Transports' recent record high earlier this week, which constitutes a Dow Theory bullish reconfirmation signal, according to Richard Russell and other analysts. 


The new Dow Theory bullish signal has occurred after both indices confirmed new intermediate lows in mid-October, which at least two analysts described as a Dow Theory bearish signal or trend change. 


Note: Victor disagrees with the notion of a Dow Theory bear signal/trend change being generated in mid-October.  The criteria used by the analysts was too simplistic as it didn't take into account time duration, percentage retracement, or volume.  That said, here's what they wrote:


1. On Oct 21st Tim Woods:   


"On Friday, October 10, 2014, the Transports closed below their August 7th Secondary Low Point. On Monday, October 13, 2014, the Industrials followed with a close below their August 7th Secondary Low Point. ...As a result of this joint close below the previous secondary low points, an orthodox Dow Theory Primary Bearish Trend change has been triggered."


2.  On Oct 31st (before the stock market closed) Chad Karnes:  "Dow Theory remains in a sell signal due to October’s confirmed breakdown...The bearish signal will remain intact until the Industrials can join the Transports in new highs (which occurred on Friday's close as noted above).

Chart Courtesy of Chad Karnes


Richard Russell shares Victor's opinion that there was no Dow Theory sell signal on Oct 13th.  In his Oct 29th Dow Theory Letters, Russell wrote:  "We've put in the initial correction lows that will now act as our bearish trigger. For the Industrials, that line in the sand comes in at 16,100.  Our bearish price threshold sits at 7700 for the Transports."


Those bearish triggers have been nullified by the Oct 31st Dow Theory's bullish re-confirmation with BOTH the Industrials and Transports making new all-time highs this past week.  And favorable seasonality begins this Monday, Nov 3rd.  Over the past 100 years, the best three-month period for U.S. stocks has been November through January.


BoJ's Shock and Awe:


Background: The BoJ calls the monetary easing program it started in April 2013 "qualitative and quantitative easing," or QQE. The qualitative part refers to the variety of assets it buys.


The BoJ announced on Friday that it plans to expand the monetary base by Y80tn a year, mainly by stepping up purchases of longer-term Japanese government bonds (JGBs). That is up from a current annual pace of about Y60tn-Y70tn ($535bn-$624bn).  It will also buy stocks (ETFs) and REITs:


·                 The amount of exchange traded funds (ETFs) and Japan real estate investment trusts (J-REITs) it wants to buy each year will triple, to Y3tn and Y90bn, respectively.

·                 The BoJ could also purchase ETFs tied to the JPX-Nikkei 400, an index of shareholder-friendly companies launched last year.

·                 The BoJ will now buy up to Y80tn of JGBs annually, up from Y50-60tn earlier, with a focus on longer-term bonds - the average maturity will move from seven years to 10.


Haruhiko Kuroda, BoJ governor, defied objections from four fellow board members, arguing that a tax-hit economy and a lower oil price have led to “a critical moment” in the effort by the world’s third-largest economy to escape 15 years of deflation (see Victor's comments which argue that Japan has experienced price stability rather than deflation.)


“It shows how other central banks are being forced into the breach left by reduced Fed stimulus,” said Alan Ruskin, strategist at Deutsche Bank.  While the BoJ cannot replace the heavy lifting done by the Fed, Mr. Ruskin said the move was likely to propel a “melt-up” for risk assets into the end of the year, led by the S&P 500, and now the Nikkei 225 index.


“For central banks [such as the BoJ and the ECB], with monetary policy at the zero bound, there is no plan B,” said Nick Gartside, JPMorgan Asset Management’s fixed-income chief investment officer.


Curmudgeon mystified by today's markets:


For many reasons, the Curmudgeon is more perplexed and bewildered by today's markets than ever before in 50 years.  The sharp U.S. stock market recovery with no change in fundamentals and no real good news or other catalyst is puzzling.  The technical action of the markets is even more bizarre. 


For example, the Russell 2000 does not behave as one would expect after its topping action this summer following its all-time high in March. After being down over 13% from its high, the Russell 2000 has led the advance off the mid October lows and has shot straight up without basing and with no catalyst to spark the rally.  That's very atypical market action and implies there is an "invisible hand" lifting the price of that index.


Gold's breakdown this week, with the mining shares being bludgeoned (down 14% on the week and at 12 year lows) is also astonishing, especially in light of Japan's new QE measures.  It's as if central banks can create infinite amounts of money out of thin air without any repercussions other than a relative decline in their currency (the Yen fell sharply against the U.S. dollar after BoJ's QE announcement).  Yet gold is real money and can't be debased like paper money.  So why didn't gold rise (rather than the US dollar) after Japan's announcement?  


The Fed and the BoJ are a money printing tag team that don't seem to remember they caused the last stock market and real estate bubbles. 


Here are a few quotes that reflect my view of the markets:


“Markets have to stand on their own two feet,” said David Ader, strategist at CRT Capital. When might that be?


"Someday what the Fed and Wall Street are doing (i.e. market manipulation) will matter.  And then you'd better stay away from the fan," John Crudele of the NY Post wrote in an email. Mr. Crudele also called attention to the Fed's verbal intervention in the market (e.g. reassuring that interest rates won't be raised anytime soon), which he said "has been going on forever."  Regarding yesterday's BoJ statement that it's going to buy stock index ETFs, John wrote:  "That's what looked like happened when U.S. stocks were in trouble. And of course they've now rallied.  The question is: how long will this trick work?"


"Capital markets have long operated under the belief that the central bank will always provide a backstop.  That is a very dangerous way to invest for the long term,” according to Tad Rivelle, chief investment officer at TCW.  "Asset prices face a period of repricing now that QE has ended," he added.  Friday's global stock market pop (courtesy of the BoJ) certainly doesn't reflect any repricing of risk.  It's simply more of the same!


It's as if global economic worries (e.g. Europe, China, etc.) have suddenly disappeared and all the geo-political problems in the world have vanished.  Judging by stock market price action and increased investor confidence, it appears that nothing can ever go wrong.


With over 50 years of market watching and seldom shy, the Curmudgeon is rarely at a loss for words.  This is one of those times...


Other Voices on the BoJ new round of QE:


David Stockman:  "Never mind that the BoJ will now escalate its bond purchase rate to $750 billion per year—-a figure so astonishingly large that it would amount to nearly $3 trillion per year if applied to a US scale GDP. And that comes on top of a central bank balance sheet which had previously exploded to nearly 50% of Japan’s national income or more than double the already mind-boggling US ratio of 25%...The scheme is so insane that the surge of markets around the world in response to the BoJ’s announcement is proof positive that the mother of all central bank bubbles now envelopes the entire globe."


Financial Times: "Beyond the shock and awe of the Bank of Japan's decision to inflate what was an already an unprecedentedly large stimulus scheme today, the interesting thing is not how much money it's printing but where that cash is going...The BoJ will now purchase Y80tn of assets per year, up from a range of Y60-70tn, in its battle to defeat the deflation ogre. That the BoJ did anything is the main shock, but Oni, a Japanese devil, is the details."


Victor Sperandeo:  Is it a Kamikaze or Hara Kara?


The Bank of Japan (BoJ) governor Haruhiko Kuroda warned that "Japan has reached a ‘critical moment’ in its battle against deflation, after announcing that the BoJ will broaden the monetary base by 80 trillion yen per year."


The BoJ will increase its bond buying to $750 billion per year or an equivalent of approximately $3 trillion a year if adjusted to a U.S. scaled GDP.  Also Japan’s state pension fund (the GPIF) is going to sell huge amounts of Japanese government bonds (JCB’s). This will enable it to reduce its government bond holdings from about 60% to only 35% of its portfolio. Then it intends to buy stocks and other assets worldwide. Gee every time the US suggests privatizing  Social Security -- the government erupts  into "it’s too risky to allow people to own stock as they can lose everything?" They then point to the stock market wipeout in the 1930's.


This was a surprise and goes to show why the markets are difficult to understand.  Governments that can't get what they wish via a chosen favorite tool or a Keynesian "stimulus" method, will NOT STOP OR CHANGE, but go on so far as to eventually commit financial suicide.  And unlike the theme song from the movie "Mash," suicide will "not" be painless.                                                                       


Let's think about the people of Japan for a moment.  They get tax increases of 60% with 40% more next April (on sales "consumption" taxes), while corporations, institutions, and stock holders/insiders get a huge bonus.  This Friday, the gift was a 5% pop in stock market wealth courtesy of BoJ's new fiat money policy (as outlined above and also earlier by the Curmudgeon).


[Meanwhile, the S&P 500 closed at a new (Hot Sake stoked) all time high on Friday.  It's now rallied 1123 days from 10/3/11 without a 10% correction. There are still many divergences such as the S&P versus the advance decline line -- which is a critical one.]


Back to Japan:  The average salary man and the elderly retired lose to politician (Socialist) elites.  It's not the nature of the Japan people to revolt in the streets as 100,000 Hungarians did over an internet tax (which was then ended).  However, if they did revolt it would bring these politicians to their senses. If not, the politicians will keep pushing the envelope till Japan crashes.


The last debt to GDP ratio for Japan (provided by Bloomberg on Sept 24, 2014) was at 240%.  Does anyone think that's a dangerous level?  The ratio is actually higher.  I firmly believe that all governments lie about these numbers, especially the U.S. with its phony accounting.


Japan is doing all this monetary stimulus in the name of fighting deflation? Japan's inflation YOY from 1994 to date was +0.14% per annum (compounded). 

[Source: -- Worldwide Inflation Data]


The BoJ somehow believes that +14 bps per year (stability!) was harmful to "the people" or "for special interest producers?"  The biggest peak to trough decline in prices was only -2.36%!  Evidently, the BoJ thinks this so called deflation (?) over the long run is enough to risk the country going into complete destruction from an insane experiment that has not worked for any country before.  It's quite a stretch to believe that BoJ buying Japanese bonds and stocks will lift the standard of living for the average person.


Victor: Markets this Week & Perspective on Gold:


Much has happened that was news worthy last week. The Fed ended QE3 -as expected. GDP was announced at +3.5%, but will likely be revised downward due to export numbers estimated for October that made GDP higher than it ought to be.  On Friday, the Hot Sake Surprise was served by Japan. That drink drove the dollar to new highs for the year, and most commodities to new lows for at least October.


Gold and silver traded at new multi-year lows on Friday Oct 31st, which is not a surprise to a long time currency trader.  Gold made an intraday low in June of 2013 of $1179 using the near spot July futures, and tested that low in December 2013 at $1177.7.  Spot gold closed at $1173.95 this Friday.


Note: Spot gold had a 12 year run from 12/31/00 thru 12/31/12, being UP each year. Although it topped in September 2011, it was still up +6.95% in 2012.  It was down (28.26%) in 2013 with a close at 1204.5 (spot). Gold is down (2.54%) this year through Friday 10/31/2014.


If gold rally's on Monday it will be a buy signal above $1178. Gold is acting fundamentally as I believe is normal.  Gold is a chaos and inflation hedge. Gold does not do well when growth (GDP) is rising or high and inflation is low.


Currently, there is no chaos such as a hot war, economic crash, etc. and no reported headline inflation. In a somewhat recent major growth period in the US (from 1982-2000) Gold declined (2.7%) a year. US GDP- whether real or fudged- has increased by 4.6% and 3.5% for the 2nd and 3rd calendar quarters of 2014, respectively. The dollar was +9.2% from the first week of April and gold was down 10.9% during the same period. That's nothing unusual to me.


On the other hand, if the EU is going to collapse (i.e. come to an end), and/or Putin takes over the Ukraine or a NATO nation like Estonia, then you will see real chaos, and I'd expect Gold to rally on such news.


Victor's Conclusions:


This is all going to end in the sage words of Tuco from the great western movie The Good the Bad and the Ugly:

"I like big fat men like you. When they fall they make more noise. And sometimes they don't get up."


When the "big fat" markets fall, they will make a lot of noise.  And they will not "get up" for a very long time!  I believe there'll be a huge hangover from the incredible phony and reckless fiat money policies of global central banks (BoJ, Fed, ECB, etc.). My conclusion is the BoJ is acting as a Kamikaze, because it will eventually kill many people -- not only the pilot.


Let's not forget that all the U.S. stock market gains have been made from fiat paper printing (QE) and borrowing (margin debt), along with zero interest rates (ZIRP). This was accomplished with the effrontery of an Al Capone. The fact that governments can accomplish all this without the objections of the people who are left behind is astonishing. But I’m always amazed that I can still be amazed at what politicians will do and get away with.


Till next time......


The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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