Sunday, March 6, 2011

Dow Jones: A word of caution

The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him.
-Leo Tolstoy, 1897

Welcome to The Golden Sense! Here we go again. It's a busy time of year, businesses are getting ready for the spring, people are hard at work, new years resolutions being tested, and the Dow Jones Industrial Average continues to rise.

What does the world economic and financial future hold? It's the trillion dollar question.

Why do you think about the future?

Answer: Because if you knew the future, you could make the correct and important decisions for yourself  today.

Many people have questions:

"What should I invest in my 401k? Should I choose domestic or foreign stocks?"

"Should I have a 401k? What about a brokerage account at Morgan Stanley?"

"Todd, I don't know how to invest...I'm just going to invest in my future and get an education. How about I take out $40k in student loans and go back to school?"

"You know Todd, I just want to shop at Whole Foods and strut around in my La Perla's. I need more money, how's the employment picture gonna look?"

You see... there are questions. Lots of the them. Guess what?
 Nobody has the definite answer on any of those questions.

However, what we can do is read the signs and follow the trend. As the great Richard Russell says "follow the money". If you want to know what going on in the world..."follow the money".

When I am talking about signs and "following the money", I am actually referring to charts. Charts are actual price trends. They show where the money has been and possibly where it is going. Charts are not talk, opinion, or political preference. They are facts.

Charts are basically historical prices that can give you a glimpse of the future as they establish a trend. Sometimes, a chart establishes a formation in which its future direction can be predictable.

In finance, technical analysis is a security analysis discipline for forecasting the direction of prices through the study of past market data, primarily price and volume.

A classic chart formation in technical analysis is called a "head and shoulders top". A chart with a head and shoulders top would look like the charts below. After the right shoulder is complete, the chart will tend to head lower and break down.






You will notice a left shoulder, a head, and a right shoulder. If you see a chart, whether it be a stock index, bond rates, or any chart for that matter take this type of formation, the odds are in its favor of heading lower. (IE: Breaking down after the right shoulder is complete).


"Wait just one minute Todd. This is crazy. How do you know the chart is headed lower? No one can predict the future."

That's correct. Nothing is guaranteed. The markets can do anything. If a chart takes a head and shoulders formation, there is no guarantee that the chart is headed lower. What the prediction is based on is probability. Probability is a measure of how likely it is that some event will occur; a number expressing the ratio of favorable cases to the whole number of cases possible.

What we do know is: If a chart forms a head and shoulder formation, the probability is in favor of the chart heading lower and breaking down. The prediction is based off of thousands of individual case studies. 

Question: OK...all this is just fine and dandy, but how in the heck does this apply to me?

Answer: We can use this technique to look at the biggest leading indicator in the American economy. I'm talking about the Dow Jones Industrial Average. Let me explain how the direction of the Dow effects you personally.

The Dow Jones Industrial Average (DJIA), is also referred to as the Industrial Average, the Dow Jones, the Dow 30, or simply the Dow. The Dow is composed of 30 very large US corporations. Such firms include Coca Cola, Walmart, Alcoa, Microsoft, AT&T, Johnson & Johnson, etc. These 30 large US companies are considered the "backbone" of the US economy. Although the Dow is indexed to gauge the performance of the industrial sector within the American economy, the index's performance continues to be influenced by not only corporate and economic reports, but also by domestic and foreign political events such as war and terrorism, as well as by natural disasters that could potentially lead to economic harm.

In short, if the Dow is heading downward then the American economy will follow. If the Dow is heading higher, the American economy will tend to improve. Like I said, the Dow is the backbone of the American economy.

The Dow's direction is important to you  if you fit any of the following:
  • Do you own a 401k or any stocks?
  • Do you have large student loans?
  • Do you have any debt?
  • Do you need a job?
  • Will you need a better job to pay off your future debt?
  • Do you want your high end stores to stay in business?
  • Do you want to start your own business?

Most people fit into one of these categories. Why? Because all of those situations are effected by the health of our economy. The action of the Dow is our leading indicator of what the economic future holds.

Lets look at a chart of the Dow from 1973 to present day. The chart reads left to right. On the bottom left hand side of the chart a huge bull market started that lasted over 20 years. Through 1980's and 1990's the Dow soared due to the tech/Internet boom along with the US becoming a sole super power in the world. In the year 2000 there was the bust of the tech bubble and in 2001 there was 9/11. The Dow headed lower. That can be identified as the left shoulder. The Dow began to climbed from 2003 to 2007 due to the housing bubble and 1% interest rates by the Fed. This can be identified as the head of the chart as it reached a high of 14164 in November 2007. Then the housing bubble burst and the Dow sunk to ominously to 6547. Since 2009 the Dow has been rising.

Take a real long, hard look at the past 10 years of this chart.



Let me propose a serious question?


Is the biggest HEAD AND SHOULDERS TOP in market history being formed????


It appears that a final right shoulder could be forming here in 2011-2012.


If the Dow heads lower there is a good chance that a head and shoulders top would be in place. Then the outlook of the American economy will look extremely bleak. If the right shoulder of the Dow chart breaks down, the Dow could sink to the low 4000 level.


"Oh come on Todd! Never in a million years. They say the recession is over. Analysts say earning will continue to improve. CNN has been reporting optimistic figures."


If the Dow does not head to record highs in the 14000's, then a head and shoulders top will be in place. The Dow and the American economy will sink lower. The head and shoulders top will not occur if the Dow chart soars to new all time highs. This is based off of real price action and technical analysis...not news, manipulated accounting practices or hopes and dreams that massive debts will magically disappear.


We all want to be optimistic. However, I would urge caution. Remember, the action of the Dow is important to us all. I believe we are coming to a critical juncture in the markets.


Many analysts might dismiss this long term chart analysis. However, something bothers me and I can't keep my eye off the Dow. All I see is a head and shoulders top.

Signing off from West Beach.
T. Norman 


Random Comments:

Once when i was young, i heard that 4 + 4=8.
I thought....hmmm really? Let me ask some people to confirm this.
I went to my English teacher and she said..." yes 4+4=8."
I went to my science teacher and he said..."yes 4+4=8."
I went to my math teacher and she said..."yes 4+4=8"
Finally, I went to my accounting teacher and asked: what is 4+4?
He pulled me to the side and with a low voice asked "what do you want it to equal?"

Just ask the guys that ran Enron...and they will confirm this for you.

The middle east is going up in smoke! Rebellion and protests are everywhere from Egypt, Lybia, Tunisia, to Iran. Is Saudi Arabia next? I hear the King is looking to give free monetary handouts to satisfy the poor. This bribery will only last so long. The invention of cell phones, the Internet, and television will push these societies to desire more freedoms and a higher standard of living. The freedom of high speed information is the catalyst. Not to mention fiat money and its role in rising food prices.
Dictators beware.

Many of these problems were predicted decades ago.

Try reading Francis Fukuyama's1992 book, The End of History and the Last Man. Or take a look at Samuel P. Huntington's book The Clash of Civilizations.

My Dad always reminds me of the Chinese sang "may you live in interesting times".

Rebecca and I just took our engagement photos up on Figueroa mountain. Matt Freeman did a great job taking the photos. We were so lucky hit the mountain on one of the nicest days this winter. Matt has a website at http://www.mattafreeman.com/

Disclaimer: The content of this article is provided without any warranty, expressed or implied. All opinions expressed in this article are those of the author and may contain errors or omissions.
No material here constitutes "investment advice" nor is it a recommendation to buy or sell any financial instrument, including but not limited to stocks, options, bonds or futures.