SubscribeDow Jones Industrial Average: Just Getting Started…
The Dow Jones Industrial Average (DJIA) has been impressive over the past few months, but the question that is on everyone’s mind is whether or not this move is sustainable in years to come. Let’s look at a quarterly chart of the Dow from 1976-present.
Here you will see that I have plotted three lines that serve to form as support and resistance. I found these lines by going back to the start of the bull market in the early 1980s. The index began trading in an upward channel whose upper and lower limits were yet to be confirmed, or at least until 1987.
Source: Bigcharts
This was a pivotal year which gave us the second points on a major market top and bottom. All I needed to do at this point was to extend the lines on their projected courses. The bottom line was never tested again as the Dow raced north and eventually bumped into the middle line in 1996 which is marked by the first black dot on the graph.
From there the Dow ventured into new territory, finally hitting a multi-year high in 2000 which is marked by the second black dot. This major peak formed the second connecting point in which I could construct my third trend line. Ironically, when the market tipped over into a recession in the early 2000s it was the second trend line that held up and showed strength in its support.
Now, let’s bring everything together. The Dow is currently trading in the channel defined by the upper two trend lines and appears poised to test the upper channel again. We won’t be able to tell for sure when it will get there, but the chances are that it will happen very soon. This would mean a minimum projection of 16,000 for the Dow Jones Industrial Average within the next couple of years.
We can’t rule out the fact that in the past the Dow has surged past these trend lines and created new ones. If the trajectory of the Dow continues past 16,000 the sky is the limit. We won’t know where the next major top will be until there is a correction that pulls the index back to historical and established trend lines. What we do know is that the trajectory seems to have accelerated over time and that a breakthrough of the 16,000 could push the index to unfathomable heights. In order to determine which trend line the Dow will hit first let’s zoom in on the charts to take a closer look.
Source: Bigcharts
In this ten-year monthly chart I am looking at the previous high established by the Dow in 2000 compared to the recent activity. As you are probably aware, the Dow has recently reached an all-time high.
What does this mean for future activity?
Well, I drew a horizontal resistance to mark the significance of the breakthrough within the past few months. Also, you will notice that the MACD and DMI are signaling to buy. Normally, when an index or security breaks a long-term resistance to the upside with conviction it is a hint that the bullish run has yet to materialize.
The mindset of most people would be to get out while things are good, but in fact you should stay in the market and shift assets into large cap growth stocks that are number one or two in their respective industries. If they pay out a dividend as well that is even better. Many of the established Dow components pay out respectable dividends because they are no longer the growth stories that attracted investors towards their price appreciation potential. Does this mean that these securities will not appreciated significantly in value over the next few years?
Of course not!
All I am saying is that you should expect good returns (10-30%), but not on the level of the technology stocks in the late 1990s bubble market.
Good Investing…
Loading ...
Comment by john w on 11 December 2006:
The problem with your analysis is that it doesn’t take into consideration the fact that either earnings or the PE ratio have to increase significantly in order for the index to increase significantly (33%).
If you look at the history of the Dow Industrials you will see that the PE ratio is relatively stable for long periods of time (currently around 19) and that it serves perhaps as more of a resistance to index growth than do price constraints. The index owners finesse this by changing the composition every once in awhile but that usually only serves to keep things stable.
We’ve just gone through an 18-month period of exceptionally high profits for many Dow components and this has driven the index higher (in my and other’s opinion). The expectation going forward is flat to lower profits over the next 18-months. Consequently there should not be a new earnings boost to raise the Dow.
I am very interested in your thinking regarding this argument
Comment by Stephen Oakes on 11 December 2006:
John,
I appreciate your comment and observations in regards to the relationship between earnings and the Dow index. I’m sure many people out there would agree with both of our opinions and analysis. Otherwise, if the market were so easy to predict and everyone had a one track mind, we’d all be rich!
I am a technician at heart, so what is presented before me I utilize and make sense of. We live during a time where irrational investors propel the markets in ways most people can not understand or imagine.
In my opinion the markets will form another bubble and rapidly deflate near the beginning of the next decade. Historically, it has been the case that recessions hit in the 0-2 year of any decade. The one historical area I am cautious about is the 7th year hit on the markets in or near October. It is hard and fast, but the markets have always recovered brilliantly. I did a post on this, but you can also google the historical statistics on this phenomenon. I do not have any reason to believe the recent surge in the Dow will end anytime soon because even my investment strategy agrees:
>DMI is positive
>MACD just turned positive
>No divergence in RSI
>Breakout above major resistance
Do you honestly believe that the Dow would reach new heights only to pullback below major support near 11,500? If this were the case, the Dow would have traded in a “double top” pattern and never have hit new highs in the first place. Then I would agree with your analysis 100%.
However, there is an underlying reason why the markets are trading the way they are. If what you say is true and the markets do pullback, they would only do so in a minimal fashion so as to test initial breakout above the 11,500 level which is common in the behavior of many securities as well.
The other thing to remember is demographics. Even though the baby boomers are retiring, most are not leaving the workforce and calling it quits. They are working either because they have to and did not save enough money or they have borrowed their lives away to sustain an economy and way of life that is proped up by debt. The corporate picture is very healthy, but we have yet to see corporate spending truly life off and help the consumer and government sectors.
The other thing to consider is that mostly all the indices and world economies are strong and growing. If there were isolated pockets of prosperity then we would have reason to be cautious.
Backtesting my strategy with the major indices has proven to be very accurate. Many would disagree with the picks I made in the Jutia Portfolio, but they have yielded abnormally high returns. Hence, I believe in my analysis.
But…I also believe that no one is right 100% of the time and I am humble enough to realize that money management via stop losses is an important way to limit any losses in the event that they occur. I will be watching the indicators very closely in case there is a change in course. In that case you can give yourself a nice pat on the back
So, that’s what is going on in my mind. Mostly technical, but a few macro doses for the reasons I am bullish right now in the overall market. Hope to hear from you soon!
Good investing my friend…
Comment by Henrietta on 12 December 2006:
Excellent analysis!
Pingback by Jutia Group » Blog Archive » Dow Jones Industrial Average: Flexing Its Muscle on 12 July 2007:
[...] Dow Jones Just Getting Started… [...]