The Dow's Statistical Convergence
by Joshua Enomoto
Dennis Gartman had had enough.
With both the S&P 500 and the venerable Dow Jones Industrial Average reaching unprecedented heights, defying the laws of market physics and the assertions of the contrarian and the "conspiracist" alike, it was time to throw in the towel. The long-time Wall Street veteran and author of The Gartman Letter knew when the jig was up and bluntly admitted as such, a stark reminder that even the most esteemed gurus can become painfully mortal at exactly the wrong time.
Mr. Gartman admitted to investors in his most recent newsletter, published on May 27th, that he and his team had it “wrong…badly…to have expected the market to correct.” According to Market Watch, an online subsidiary of The Wall Street Journal, there were 4 reasons cited by Gartman and crew as to why the call was misguided :
On the other hand, not knowing the outcome of the future is not an excuse to avoid putting forth the best scientific rigor towards any forecasting activity. Does the potential for inaccuracy in a weather report cause an event coordinator to completely ignore warnings of potential thunderstorms that may threaten a key speaking engagement? The reasonable action would be to prepare for its possibility while holding out for hope that nature would be cooperative. Understanding the importance of this critical service, weather forecasting teams throughout the country will continue to apply their highest efforts into accuracy and consistency, despite the ever-present threat of not getting it right.
All of us that work in industries involving uncertainty (ie. all white-collar jobs essentially) recognize that forecasting is a necessity, even if it is a "work-in-progress." Retailers may not know for certain whether a product will be a hit with their shoppers, but ultimately, somebody has to make a determination of how much inventory to carry within their distribution centers. Merely throwing hands up in the air and stating that forecasting is not a 100% science is an exercise of acquiescence, a loser's mentality.
Which is why the response from The Gartman Letter team is all the more perplexing. Reasons #1 through #3 are nothing more than a trivial recitation of historical data layered in the language of technical analysis, or the popular discipline employed by professional market participants to strategize their next move. Reason #4 is similar in tone, but heavily biased : the long trade (or being bullish) really hasn't been the unpopular trade as there's obviously people willing to buy equities at current valuations. Otherwise, how else could the market go up?
I don't fault Mr. Gartman and his team for "getting it wrong." It happens to every single person involved in the financial industry and this will certainly not be the last time when the markets do something unexpected. I am, however, disappointed that their admission was followed by nonsensical reasoning. I'm wrong because I'm wrong! So there! It's almost as if the admission was uttered to divert attention away from the explanation and not the other way around.
This is the tragedy : if the reasoning was still valid, the forecast itself may still be salvageable. Certainly, it would not be as relevant from a short-term perspective, but this is a matter most prescient to daytraders. To me, that is a gamble but it happens to float the fancy of several high-strung individuals and far be it for me to criticize. But a well-researched analysis can provide clarity and open doors to potential correlations not witnessed before. I would still be grateful for a tornado warning even if it came a few weeks too early, considering that the consequences for ignoring the assessment would far outweigh the rewards.
For Mr. Gartman's clientele, this is the same aggression in scope. He wasn't talking about a five-percent chance of a light drizzle in Phoenix, Arizona. He was warning about a steep correction, one that could potentially threaten his clients' portfolios. So if he had a reason to sound the alarm (and Mr. Gartman is not a doom-and-gloom Chicken Little), we would all like to hear why, and more importantly, why he now believes that the alarm-sounding was a mistake. I'm sure his clients would love to know more than merely a simple admission of inaccuracy.
But if you think I am here to pile onto Mr. Gartman, kicking sand into the face of a downed combatant, you have the wrong impression. In fact, quite perfectly on the contrary, I am here to defend his initial thesis! The second mistake that was committed was not sticking to the original plan : sure, the markets may do some funky things that run counter to logic and intuition, but the large-cap equities sectors are ultimately tied to the economy. And unless there's some magic powder GDP booster that I am unaware of (and no, I'm not talking about legalization of cocaine), it's absolutely reasonable to believe that the markets will eventually and inevitably correct.
The stock market is not run on mysticism whose meanderings are only decipherable by an elite few. It's simple supply and demand, a negotiation between buyer and seller. He who buys will do so at a price that is comfortable. What "comfortable" means is different for everyone. But if enough buyers start feeling uncomfortable, a shift will occur. Supply of equity shares will flood the market while prices will become depressed as a result. Perhaps at some later time, buyers will become confident again and re-engage these now discounted shares. The cycle continues.
What makes the major indices unique is that they measure the performance of blue-chip companies, those that are leaders in various industries and command billions in leverage. Their health and stability is dependent on those same qualities of the underlying economy. If the entire country falls under crisis, the risks would reverberate throughout major companies as their revenue stream typically comes at the price of exceptionally high overhead. And when the U.S. equities sector accounts for roughly half of the world's market capitalization, no one, not even our worst enemies, wants to see an America in disarray.
Of course, this is a topical overview and because of this, lacks a degree of specificity. We need something more than a mere recognition that events carry the possibility of going awry. To engage the granularity of the forecasting game, many investment analysts rely either on the aforementioned technical analysis or fundamental analysis, essentially the discipline of accounting by any other name.
Both of these disciplines demonstrate at minimum a modicum of validity. Fundamental analysis is the Wall Street standard and rarely falls under empirical criticism. However, it must be noted that an incredible number of investors take liberties with its accounting principles and often conjure forward-basis correlations that have nothing to do with accounting itself. Accountants by nature are a conservative group and I find it difficult to believe that speculation is part of the bean-counting ethos.
Technical analysis, on the contrary, is the whipping boy of empirical criticism. Even its ardent apologists must admit that the denigration is impossible to deflect : there's no way to prove that the suppositions forwarded by technical analysis, particularly those of the subdivision known as Elliot Wave Theory, have a scientific or statistically valid basis due to the definitional variability of the suppositions themselves. For example, it's difficult to make the claim that all cars are fuel-efficient when the definition of cars involves anything from 4-wheel drive suburban utility vehicles to two-wheeled human propelled bicycles.
When applied properly, the combination of the fundamental and technical approach, sometimes referred to as "technimental analysis," can be a very powerful weapon and has no doubt been wielded as such by Mr. Gartman and his excellent group of researchers and writers. However, we can apply one more element to the mix to provide a complete picture : statistical analysis.
Of the three methodologies, the statistical approach is the only one that is a science. Fundamental analysis is an art because accounting is an art. That is not to say that accounting is a whimsical industry ; on the contrary, the accounting regiment is amongst the most meticulous (especially in the wake of the early 2000's accounting scandals) but there's variability in the legal definition of bookkeeping entries. And since accounting is in many ways "the law of numbers" (and we all know how the law can be twisted!), it's difficult to categorize the discipline as a science.
Technical analysis is improperly named, a more suitable characterization being "trend analysis" or "market psychology." Some of its methodologies is a science, for example, weighted averages of historical price data and the proportion of advancing days over declining days, but mostly, the math involved is very rudimentary and the suggested implications are equally basic (buying or selling when the current price of an asset reaches a specific mathematical average).
Statistical analysis provides a black and white assessment of the market. Given certain parameters, what are the specific probabilities that a stock or asset will move in one direction or another? Fundamental analysis answers this question by providing a public statement of facts and figures by which an investor must speculate on how other investors will react. Technical analysis responds by providing price and volume dynamics that may be similar to dynamics that occurred in the past and requiring an investor to make a reasonable decision. Only statistical analysis gives you a hard number towards a successful outcome.
On any given day, if an investor could theoretically purchase a share of the S&P 500 index, the probability that his investment will advance the following day is roughly 54%. However, those odds change noticeably depending on what day of the week the purchase was made, and even then, the time of the year also adds its own leverage.
Over the long-term, an investor has an estimated 60% chance of making money simply by buying a fund that tracks the performance of the S&P 500. But that probability can fluctuate during the seasons and also, the events that occurred in the recent past. Would it not make sense to completely avoid large-cap equities during moments of high risk probability and instead, shift funds into alternative markets that offer high reward probability?
That's the beauty of statistics! It's the only science that gives you an appraisal of the markets that is free from conjecture or bias. By looking strictly at the hard data and only making an inference based on its indisputable evidence, an investor can truly manage his risks. Just like a football coach doesn't call up plays at random but looks at the down, yardage, and the clock, no one should throw money blindly at the markets without reigning in on its immense variability.
Which brings us back to Mr. Gartman's defense : his initial thesis has not yet been proven wrong because his core argument is still valid. Based on empirical research, the higher the markets climb during these early summer days, the greater the risk that at some point in the near future, we will incur a severe correction. As the country and many of its financial analysts embrace record levels in the Dow Jones and the equity market complex, the price dynamic has hit upon a statistical confluence, one that has bearish omens.
Does that mean that the markets are guaranteed to fall? Let's ask the question a different way : does going for it in the 1st quarter on a 4th and 20 situation backed in to your own end zone guarantee that you won't convert for the first down? In both cases, the answer is no. However, the deliberate ignorance of critical data is hardly the recipe for long-term success. A lucky shot cannot always be depended upon and the probabilities always wins out in the end (and if you don't believe me, just look at the casino industry...).
Investing, whether for a quick buck or a part of a retirement strategy, is all about winning. Throwing darts in the air based on assertions, other peoples' reputation, or gut feelings will not get you there. Unfortunately, many mainstream financial analysts appear to be taking the low-hanging fruit and avoiding the hard, empirical approach to market analysis. This is a detriment to the entire investment community who are depending upon well-researched assessments.
The journey may only be getting more difficult for Dennis Gartman...
Dennis Gartman had had enough.
With both the S&P 500 and the venerable Dow Jones Industrial Average reaching unprecedented heights, defying the laws of market physics and the assertions of the contrarian and the "conspiracist" alike, it was time to throw in the towel. The long-time Wall Street veteran and author of The Gartman Letter knew when the jig was up and bluntly admitted as such, a stark reminder that even the most esteemed gurus can become painfully mortal at exactly the wrong time.
Mr. Gartman admitted to investors in his most recent newsletter, published on May 27th, that he and his team had it “wrong…badly…to have expected the market to correct.” According to Market Watch, an online subsidiary of The Wall Street Journal, there were 4 reasons cited by Gartman and crew as to why the call was misguided :
- The world’s markets have not corrected;
- New highs keep being made in any number of various indices;
- The trend remains ‘From the lower left to the upper right’
- Long has been the difficult trade, the unpopular trade and the “hard trade that few really have recognized even as prices simply continued to advance.”
On the other hand, not knowing the outcome of the future is not an excuse to avoid putting forth the best scientific rigor towards any forecasting activity. Does the potential for inaccuracy in a weather report cause an event coordinator to completely ignore warnings of potential thunderstorms that may threaten a key speaking engagement? The reasonable action would be to prepare for its possibility while holding out for hope that nature would be cooperative. Understanding the importance of this critical service, weather forecasting teams throughout the country will continue to apply their highest efforts into accuracy and consistency, despite the ever-present threat of not getting it right.
All of us that work in industries involving uncertainty (ie. all white-collar jobs essentially) recognize that forecasting is a necessity, even if it is a "work-in-progress." Retailers may not know for certain whether a product will be a hit with their shoppers, but ultimately, somebody has to make a determination of how much inventory to carry within their distribution centers. Merely throwing hands up in the air and stating that forecasting is not a 100% science is an exercise of acquiescence, a loser's mentality.
Which is why the response from The Gartman Letter team is all the more perplexing. Reasons #1 through #3 are nothing more than a trivial recitation of historical data layered in the language of technical analysis, or the popular discipline employed by professional market participants to strategize their next move. Reason #4 is similar in tone, but heavily biased : the long trade (or being bullish) really hasn't been the unpopular trade as there's obviously people willing to buy equities at current valuations. Otherwise, how else could the market go up?
I don't fault Mr. Gartman and his team for "getting it wrong." It happens to every single person involved in the financial industry and this will certainly not be the last time when the markets do something unexpected. I am, however, disappointed that their admission was followed by nonsensical reasoning. I'm wrong because I'm wrong! So there! It's almost as if the admission was uttered to divert attention away from the explanation and not the other way around.
This is the tragedy : if the reasoning was still valid, the forecast itself may still be salvageable. Certainly, it would not be as relevant from a short-term perspective, but this is a matter most prescient to daytraders. To me, that is a gamble but it happens to float the fancy of several high-strung individuals and far be it for me to criticize. But a well-researched analysis can provide clarity and open doors to potential correlations not witnessed before. I would still be grateful for a tornado warning even if it came a few weeks too early, considering that the consequences for ignoring the assessment would far outweigh the rewards.
For Mr. Gartman's clientele, this is the same aggression in scope. He wasn't talking about a five-percent chance of a light drizzle in Phoenix, Arizona. He was warning about a steep correction, one that could potentially threaten his clients' portfolios. So if he had a reason to sound the alarm (and Mr. Gartman is not a doom-and-gloom Chicken Little), we would all like to hear why, and more importantly, why he now believes that the alarm-sounding was a mistake. I'm sure his clients would love to know more than merely a simple admission of inaccuracy.
But if you think I am here to pile onto Mr. Gartman, kicking sand into the face of a downed combatant, you have the wrong impression. In fact, quite perfectly on the contrary, I am here to defend his initial thesis! The second mistake that was committed was not sticking to the original plan : sure, the markets may do some funky things that run counter to logic and intuition, but the large-cap equities sectors are ultimately tied to the economy. And unless there's some magic powder GDP booster that I am unaware of (and no, I'm not talking about legalization of cocaine), it's absolutely reasonable to believe that the markets will eventually and inevitably correct.
The stock market is not run on mysticism whose meanderings are only decipherable by an elite few. It's simple supply and demand, a negotiation between buyer and seller. He who buys will do so at a price that is comfortable. What "comfortable" means is different for everyone. But if enough buyers start feeling uncomfortable, a shift will occur. Supply of equity shares will flood the market while prices will become depressed as a result. Perhaps at some later time, buyers will become confident again and re-engage these now discounted shares. The cycle continues.
What makes the major indices unique is that they measure the performance of blue-chip companies, those that are leaders in various industries and command billions in leverage. Their health and stability is dependent on those same qualities of the underlying economy. If the entire country falls under crisis, the risks would reverberate throughout major companies as their revenue stream typically comes at the price of exceptionally high overhead. And when the U.S. equities sector accounts for roughly half of the world's market capitalization, no one, not even our worst enemies, wants to see an America in disarray.
Of course, this is a topical overview and because of this, lacks a degree of specificity. We need something more than a mere recognition that events carry the possibility of going awry. To engage the granularity of the forecasting game, many investment analysts rely either on the aforementioned technical analysis or fundamental analysis, essentially the discipline of accounting by any other name.
Both of these disciplines demonstrate at minimum a modicum of validity. Fundamental analysis is the Wall Street standard and rarely falls under empirical criticism. However, it must be noted that an incredible number of investors take liberties with its accounting principles and often conjure forward-basis correlations that have nothing to do with accounting itself. Accountants by nature are a conservative group and I find it difficult to believe that speculation is part of the bean-counting ethos.
Technical analysis, on the contrary, is the whipping boy of empirical criticism. Even its ardent apologists must admit that the denigration is impossible to deflect : there's no way to prove that the suppositions forwarded by technical analysis, particularly those of the subdivision known as Elliot Wave Theory, have a scientific or statistically valid basis due to the definitional variability of the suppositions themselves. For example, it's difficult to make the claim that all cars are fuel-efficient when the definition of cars involves anything from 4-wheel drive suburban utility vehicles to two-wheeled human propelled bicycles.
When applied properly, the combination of the fundamental and technical approach, sometimes referred to as "technimental analysis," can be a very powerful weapon and has no doubt been wielded as such by Mr. Gartman and his excellent group of researchers and writers. However, we can apply one more element to the mix to provide a complete picture : statistical analysis.
Of the three methodologies, the statistical approach is the only one that is a science. Fundamental analysis is an art because accounting is an art. That is not to say that accounting is a whimsical industry ; on the contrary, the accounting regiment is amongst the most meticulous (especially in the wake of the early 2000's accounting scandals) but there's variability in the legal definition of bookkeeping entries. And since accounting is in many ways "the law of numbers" (and we all know how the law can be twisted!), it's difficult to categorize the discipline as a science.
Technical analysis is improperly named, a more suitable characterization being "trend analysis" or "market psychology." Some of its methodologies is a science, for example, weighted averages of historical price data and the proportion of advancing days over declining days, but mostly, the math involved is very rudimentary and the suggested implications are equally basic (buying or selling when the current price of an asset reaches a specific mathematical average).
Statistical analysis provides a black and white assessment of the market. Given certain parameters, what are the specific probabilities that a stock or asset will move in one direction or another? Fundamental analysis answers this question by providing a public statement of facts and figures by which an investor must speculate on how other investors will react. Technical analysis responds by providing price and volume dynamics that may be similar to dynamics that occurred in the past and requiring an investor to make a reasonable decision. Only statistical analysis gives you a hard number towards a successful outcome.
On any given day, if an investor could theoretically purchase a share of the S&P 500 index, the probability that his investment will advance the following day is roughly 54%. However, those odds change noticeably depending on what day of the week the purchase was made, and even then, the time of the year also adds its own leverage.
Over the long-term, an investor has an estimated 60% chance of making money simply by buying a fund that tracks the performance of the S&P 500. But that probability can fluctuate during the seasons and also, the events that occurred in the recent past. Would it not make sense to completely avoid large-cap equities during moments of high risk probability and instead, shift funds into alternative markets that offer high reward probability?
That's the beauty of statistics! It's the only science that gives you an appraisal of the markets that is free from conjecture or bias. By looking strictly at the hard data and only making an inference based on its indisputable evidence, an investor can truly manage his risks. Just like a football coach doesn't call up plays at random but looks at the down, yardage, and the clock, no one should throw money blindly at the markets without reigning in on its immense variability.
Which brings us back to Mr. Gartman's defense : his initial thesis has not yet been proven wrong because his core argument is still valid. Based on empirical research, the higher the markets climb during these early summer days, the greater the risk that at some point in the near future, we will incur a severe correction. As the country and many of its financial analysts embrace record levels in the Dow Jones and the equity market complex, the price dynamic has hit upon a statistical confluence, one that has bearish omens.
Does that mean that the markets are guaranteed to fall? Let's ask the question a different way : does going for it in the 1st quarter on a 4th and 20 situation backed in to your own end zone guarantee that you won't convert for the first down? In both cases, the answer is no. However, the deliberate ignorance of critical data is hardly the recipe for long-term success. A lucky shot cannot always be depended upon and the probabilities always wins out in the end (and if you don't believe me, just look at the casino industry...).
Investing, whether for a quick buck or a part of a retirement strategy, is all about winning. Throwing darts in the air based on assertions, other peoples' reputation, or gut feelings will not get you there. Unfortunately, many mainstream financial analysts appear to be taking the low-hanging fruit and avoiding the hard, empirical approach to market analysis. This is a detriment to the entire investment community who are depending upon well-researched assessments.
The journey may only be getting more difficult for Dennis Gartman...
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*At this time, we can only accept publicly traded stocks or funds available in the U.S. We cannot accept requests for commodities (ie. gold spot-price), futures contracts (ie. crude oil), derivatives markets (ie. options contracts), or any "exotic" financial instruments. For any questions, please reach out to us at invest@jyefinancial.com before placing an order.
Please allow 48 to 72 hours for delivery of report to your email address.
Here's how this works : once you place your order, send us an email at invest@jyefinancial.com with your stock pick*, and we will send you a 2-3 page report detailing its key statistics.
*At this time, we can only accept publicly traded stocks or funds available in the U.S. We cannot accept requests for commodities (ie. gold spot-price), futures contracts (ie. crude oil), derivatives markets (ie. options contracts), or any "exotic" financial instruments. For any questions, please reach out to us at invest@jyefinancial.com before placing an order.
Please allow 48 to 72 hours for delivery of report to your email address.
