Dow Theory Signals

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“The global political risk surge has dramatically altered the Risk-Reward in U.S. equities. Our focus is on the risk connections across the EU, Germany, Italy, Sweden, China (trade) and the United Kingdom (Brexit). Our analysis of the financial path forward centers around a number of catalysts, and their impact on global markets and central bank promises. Bottom line: Look for stress in emerging markets (trade) and Europe to dramatically alter the Fed’s policy path. To us, 2018 looks a lot more like 2011 (Grexit) or 2015 (China Currency Devaluation) than 2017’s “risk on” (low equity market volatility) party. U.S. equities will move 10-15% lower, the beast inside the market will break the Fed over its knees. Once again, credit risk is about to veto the Fed’s policy path (far fewer rate hikes than the Street expects). “

Bear Traps Report, July 2, 2018 – “Credit Risk Veto”

How does one spot the end of a great bull market and the birth of a bear’s mauling? We can start with the Dow Theory.

The Dow theory asserts that major market trends are composed of three phases: an accumulation phase, a public participation (or absorption) phase, and a distribution phase. Bottom line; it’s a classic indicator of real selling. Just before the genesis of a bear market, the weak hands are flushed out. Fast money investors without deep investing commitments run for the hills first.  In July, we did a solid job for clients in getting them out of the FAANGs (shorts as well), another classic, fast money hang-out. To us, what makes this indicator so important is meticulously measuring signs of real money selling. In many instances historically, the real selling doesn’t begin until there’s a Dow Theory signal. Beware, we may have touched a trigger Friday, just as the Fed continues to pursue their beloved rate hikes.  Pick up our latest report here. 

The Dow Theory on stock price movement is a form of technical analysis that includes some aspects of sector rotation. The theory was derived from Wall Street Journal editorials written by Charles H. Dow (1851–1902), journalist, founder and first editor of The Wall Street Journal and co-founder of Dow Jones and Company.

Since the Mid-September US Equity Market Highs

Brazil EWZ: +24%
Utilities IDU: +6%
Gold GLD: +4%
China FXI: +3%
Consumer Staples XLP: +2%
US Treasuries TLT: +2%
Emerging Markets EEM: -2%
UK EWU: -10%
Dow Industrials: -10%
S&P 500 SPY: -11%
Italy EWI: -12%
Biotechs IBB: -12%
Germany EWG: -13%
Consumer Discretionary XLY: -14%
Eurozone Financials EUFN: -14%
Dow Transports: -18%
Russell IWM: -19%
Energy XLE: -20%
Retail XRT: -20%

Regional Banks KRE: -24%
Apple AAPL: -27%
Oil USO: -27%

*Deeply embedded in a bear market: Eurozone banks EUFN are 35% off their 2014 highs, German equities EWG are 30% off their January highs, Italian equities EWI are 32% off their 2014 highs, UK equities EWU are 32% off their 2014 highs. US retailers are on course for their biggest quarterly sell-off since the financial crisis. It’s important to note, US economically sensitive sectors (transports, regional banks, home construction, consumer discretionary) dramatically underperforming above. Credit markets are freezing up. This month companies have NOT been able to raise capital through the $1.2tn US high-yield bond market. This would mark, the first full month since November 2008 (just after the failure of Lehman Brothers) that not a single junk bond was able to price.

Dow Theory’s Ambassador

Over the years the Dow Theory had many ambassadors, none more prominent than Richard Russell. He was born in New York, the son of Hortense (Lion) Russell, a novelist, and Henry Harold Russell, a civil engineer. He began publishing a newsletter called the Dow Theory Letters in 1958. The Letters covered his views on the stock market and the precious metal markets.

Ahead of the Trend

Some say the Dow Theory has been ahead of the market for nearly a century. One academic study from the 1990s calculated the theory’s track record over the prior seven decades, back to when it was created in the early part of the last century; the study found that the Dow Theory beat the broader market by an average of 4.6% points a year.

Risk Indicators and Economic Philosophy 

People conflate the Dow Theory sell signal and the philosophy behind it. The overarching idea is that transports fall before industrials because the timing of their business cycles is different. But that isn’t the same as the Dow Theory sell signal. It’s the underlying theory supporting the Dow theory sell signal and buy signal. Dow theory should not be confused with Dow Theory signal.

Trannies Don’t Lie
Dow Theory Triggers: Above you can see three lower lows in the (yellow) Dow Jones Industrial Average, -10.3% off her September highs and two lower lows in the (white) Dow Transportation Average, -18.3% off her September high.

“With a cross-asset view (emerging market currencies, eurodollar/Fed funds, gold, and silver); bets on a “one and done” Fed have dramatically outperformed U.S. equities in Q4 and are all pointing to early signs of a softer Fed policy path. Looking down the road ahead, the U.S. equity market will CRASH in 1987 style if the Fed plays tough guy, it’s that simple. Similar to the March 2016 landscape, the market is about to embarrass the Fed yet again. As we have stressed over the last few months, they will capitulate (call off future rate hikes) in our view.”

Bear Traps Report, November 15, 2018

The Flush to Come

There have been significant tops that Dow Theory sell signals did not catch. So paying attention to the philosophy may prove more important than catching a classic signal.  Market participants need to review the theory at this point, there’s too much on the line. Friday,  we closed right at major support on the industrials. A flush from here would bring colossal real money selling, and confirm the beginning of a new bear market in our view.  What we found particularly troubling about yesterday was that we had good news on China and the market still flopped.

Bullish Signals for US Equities
One important risk indicator we use is the Index of NYSE stocks % above their 200-day moving average. On Friday, she touched 23%. In the Post-Lehman era, this level has only been breached three times; 2011, 2015 and 2016. US equities as measured by the S&P 500 bounced 31%, 16% and 21% in the six months following these HIGH capitulation levels.

Triggered or Not?

Some argue the Dow theory isn’t triggered until the averages (Dow and Dow Transports) go to a new high and the other DOES NOT.  The idea being you have an UNCONFIRMED new high FOLLOWED by CONFIRMED new lows. To our eye that has not happened.

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A Wall St. Legend Leaves Us with Timeless Lessons

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A Wall St. Legend Leaves Us with Timeless Lessons

Larry McCarthy 1964-2013

Wall St. lost a legend five years ago this week.  Over the last two decades, Larry McCarthy was probably most respected junk bond trader, a man with fearless resolve.  He was one of a kind and touched so many people in positive ways. The only thing that outshined Larry’s inspiration to others was found in his generosity.

Stories of Larry’s passing have been widely read.  Over the last week, his profile was the most viewed globally across the Bloomberg terminal.  He will be missed by many, the man left a mark.

Authors Patrick Robinson (left), Larry McDonald (right) and Larry McCarthy (middle).

Best known for New York Times #1 Bestseller “Lone Survivor,” Patrick Robinson joined Larry McCarthy and Larry McDonald at speaking events across the U.S. in the summer of 2009.


McCarthy’s Legend Lives On

He’s best known as the former Lehman Brothers’ executive who predicted that credit-default-swap traders were “working on bringing down the whole world.”   McCarthy placed over $1.5 billion of bets against Countrywide Financial and Beazer Homes, he was a trader with unique market insticts, true vision.  Before the crash, he wisely left the doomed firm in 2007, and made his fateful declaration to a large audience at his retirement party.   It’s the stuff legends are made of.


“The debtors’ conduct, on its face, is suspect.”

Larry McCarthy


Classic Lessons

Hidden below, are some classic trading lessons that have more to do with psychology and attitude than anything else, virtues McCarthy mastered.

 As a tribute to Larry, this is an excerpt from the New York Times bestseller “A Colossal Failure of Common Sense.”

It was the Fall of 2005, the one person in all of Lehman Brothers who believed implicitly that analyst Jane Castle was correct, was Larry McCarthy. One of the most fearless traders ever to work on Wall Street, he would hear no word against her assessment of the Delta situation, and indeed had, working in concert with Joe Beggans and I, bought $750 million worth of the airline’s bonds during the company’s bankruptcy. He was keenly aware that it may be months before the price climbed to the levels Jane predicted. But he was sure of our position. And like all true gamblers, he was sure that his luck was running.

As a matter of fact he kept buying all through the next month, whenever an opportunity came up.  In truth, the situation at Delta itself did not really improve. Unrest in the Middle East continued, and the pilots were threatening to strike, which would blow Delta’s normal operations asunder, and cut off their cash-flow, which was, at this stage, their life blood. Larry was, however, adamant.

“It’s what Jane says. Those bonds are worth a lot more than 12 cents on the dollar. They got damn Boeings, hundreds of ‘em, parked all over Georgia.” (A year later the bonds traded at 65.)

It’s difficult to grasp the size of the gamble Larry was involved in, just as it’s difficult to grasp the type of man Larry was – it’s difficult to gauge his astuteness, the speed of his calculations, and the depth of his nerve. You’ll have to take my word for it, there was nothing ordinary about him. Larry McCarthy had stepped straight out of a scene from the Cincinatti Kid.


“Are you long because you like it, or do you like it because you’re long?”

Larry McCarthy


Hall of Fame Junk Bond Trader

He was world-class at both blackjack and stud poker. He was our very own Lehman Kid, cards or stocks, he had nerves of sprung steel, and a radar for those moments when Lady Luck was with him. He had a nose for victory, and an instinct for trouble. And when he scented the former, there was no shaking him off.

He and I used to go off gambling together. I suppose it was in our blood, and there’s a lot of guys like that on Wall Street, cold and determined with the firm’s cash, but addicted to the chase, calculating the odds, the risk reward ratio. I guess we’re all junkies for the thrill of being right, of winning, always winning.

Summer of 2013

“In trading, the pain and fear you feel is in direct proportion to the size of the opportunity.”

Larry McCarthy

One Unforgettable Night

I’ll tell you just one story about McCarthy, and then you’ll know precisely what manner of man held those Delta bonds. It was around that time in the year, as I said the Fall of 2005, and we had decided to have a couple of days up at Mohegan Sun, the spectacular Indian reservation casino in the deep woods of Connecticut on the banks of the Thames River.

These were days of immense prosperity for the investment banks and we were entertaining some heavy-hitting clients. After dinner at Michael Jordan’s Steakhouse, we headed for the tables for some high-rolling blackjack.

I settled into a modest corner where the stakes were around $50-$100. McCarthy went to $100-$500, a spot he had occupied many, many times before. But by any standards you’d have to say the cards were not running for him. He slogged it out, going head to head with the dealer, but nothing could change his luck. After two hours he’d blown a very large hole in $75,000. An hour later he’d lost $100,000. The dealer was pulling seven-card 21’s, and never busting.

I saw him three times double down on a 10, and then pull a 10; only for the dealer to hit 21 again, and then again. The pressure was relentless. The shocking bad luck apparently endless. But McCarthy never flickered, never stopped smiling, never stopped wisecracking his way through the evening. Never once did he lose his cool, laughing cheerfully with the pit bosses, and the dealers, who knew, to a man, the cards had turned against him, before he even started.

After four hours he had blown out $165,000. Nothing had gone right, nothing had been even reasonable. Lady Luck had sure as hell cashed her Delta bonds. But Larry stayed positive, once handing the cocktail waitress a $500 tip. Finally, I found it impossible, even if he could go on taking this financial bashing. I took him aside and told him, “Come on, Buddy, this is a disaster. I’ve calculated your losses. You’re $165,000 down. Let’s call it a night.”

I’ll never forget his reply. He stared at me hard, and he said, “This is all about positive staying power, old pal.  Most people quit in life when they’re just three feet from the gold. But you got to be there with the big bucks, for the turn. Because it always turns. Remember that. Everyone has good luck. Everyone has bad. Just don’t stampede for the f…ing exit when there’s a minor setback. Because it’s gonna turn. Trust me, it’s gonna turn, and that’s when you want to be there.”


“Always take a long look around the table for the sucker – if you can’t find him – it’s probably you.”

Larry McCarthy


Table Max

I just shook my head, at the sheer guts of the man. And he told me to call the pit-boss and get another $100,000. He was playing on, and his credit was good.

Both on the trading floor and in the casinos, most guys run for the hills when things aren’t going their way. Bad negative attitudes, whiners and complainers. But not Larry. On the trading floor and at the tables, he was always Captain Cool, waiting patiently, lying in wait for his moment.

He asked us to give him a little room. Then he collected his $100,000 and took over the whole table, all six slots. They roped off the area, except for him and me, and he started with $2,500 on each hand, that’s $15,000 on each round against the dealer. That gave him a very slight advantage, because there was no one else playing, catching the good hand. I watched him win a few, then lose a few. And then, suddenly, the dealer, ‘busted’ two hands in a row for the first time in close to five hours. Larry hauled back $15,000. Then he pulled something which was nothing less than a mind-blower.

He gestured to the pit-boss and requested permission to up the table-max from $5,000 a hand, $30,000 a table. “Let’s get this baby up to $10,000,” he said. “$60,000 a table.”

The pit-boss nodded, and came back with a new sign which read, “Table Max $10,000 a hand.” Larry proceeded to pile on his $1,000 chips, ten of them on all six slots. But the cards were not pretty. His best was a 16, but the dealer’s cards were worse.

There was a six, but when the second card turned, it was the dreaded five, and this meant if she drew a face-card she had 21, and Larry was down another $60,000.

The dealer, still under 17, had to go again. Almost 30 people crammed outside the ropes, watching this fight to the finish, holding their breath. The dealer turned the card. It was a three, which made 14. Larry never blinked. The dealer turned again, an ace, for 15. Larry stared straight ahead. And the dealer turned again, and pulled yet another ace. That was still only 16. This was sensational. But the dealer had to turn again. And it was as if the heartbeat of the entire casino had come to a halt. The pit-bosses had moved in and were standing watch with the crowd. Cocktail waitresses stopped serving, and a kind of telepathy swept around the gaming room. It was as if everyone was aware of the titanic struggle between the casino’s ace dealer, and Larry McCarthy from Wall Street, with $70,000 riding on the turn of a card.

I watched the dealer gasp, and then reach for the ‘shoe,’ selecting the card. For a split second, the hand that covered that card paused, and then spun it over, to reveal the Queen of Spades. Dealer’s bust – 26.

After five hours, Larry’s luck had finally turned, and he leapt at me, tackled both of us right off our stools, into the velvet ropes and on to the floor in front of all the spectators, both of us laughing fit to When we finally climbed back to our feet, Larry just said, “Okay, guys, let’s play some cards.” He swapped the $1,000 orange chips, the ‘pumpkins,’ for the $5,000 ‘Grey Ladies,’ and placed two of them on each spot, a $60,000 hand. And when the cards came up they were devastating – for the dealer. Four blackjacks and two 20’s for Larry ! Against the dealer’s pitiful 17.

In 35 minutes, Larry had come back from the dead to be $25,000 in front. “Remember this,” he said, “You’ve seen for the past four hours the best part of this game, trading and the very best part of life.  When you think things can’t get any worse, they always do, and when they can’t get any better, they always do.”

And what he said was true. I’d watched this man, beaten and beaten, and in the next two hours I watched him ride his luck, all the way back. When we walked out of there, he was $475,000 in front. I saw it with my own eyes. I think for the first time, I finally understood why Larry McCarthy was a full-blooded Legend of Wall Street, and his name would live for a long time.

On the way out, he told me one more truth, as applicable in the market as it had been at the table. “Never blow your powder too early,” he said. “Start nice and slow, nice and low. Get the feel of the market, get centered, make sure you got a ton of ammunition, and don’t quit too early. Never do that. When they’re running against you, keep going, because they’re gonna turn. And in the split-second they make that turn, hit it, buddy, hit it real hard. Because that’s when you’re gonna WIN.”

Larry McDonald is creator and editor of the Bear Traps Report, a weekly independent investment letter focusing on global political and systemic risk with actionable trade ideas. Larry serves as a political policy risk consultant to hedge funds, family offices, asset managers and high net worth investors. Larry was former Head of US Macro Strategy at Societe Generale, and frequent guest contributor on Bloomberg TV, CNBC, Fox Business, and the BBC. Larry is a NY Times bestselling author, his book “Colossal Failure of Common Sense” is now translated into 12 languages. He ran a $500 million proprietary trading book at Lehman Brothers, made over $75 million betting against the subprime mortgage crisis and was consistently one of the most profitable traders in the firm. His “Bear Traps” letter is one of the most highly regarded on Wall St. He’s participated in 3 major financial crisis documentaries: Sony Pictures, Academy Award winning documentary the “Inside Job,” BBC‘s “The Love of Money” and CBC‘s “House of Cards.” He’s delivered over 125 keynote speeches in 17 different countries, at Banks, Investment Firms, Conferences, Law Firms, Insurance Companies and Universities.

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