Dow Theory…1974

This is a special Letter . If there are typos, please excuse us . Why a special? Because certain ideas have clarified in my mind, ideas that I introduced in the last few letters, and I want to get them to you now. I do change and alter my ideas - that’s why I publish 36 Letters a year instead of a dozen!

“Consider the work of God; who can set straight what he has made crooked? When times are prosperous, enjoy your happiness ; when times are bad, consider this: The one is God’s doing, as is the other, in order that man may know nothing of his destiny. . ., . ” Ecclesiastes 7:13

THE MARKET: Like the Biblical writer above, we know little of our personal destiny or our investment destiny . I have succeeded so far in keeping my subscribers out of the worst market collapse since 1929-32. For eight years I have held steady to a policy of cash (or Treasury bills), gold shares and unlimited patience . I presume that I must have done something right, because over the past year (during these most difficult times) subscriptions to this report have. doubled, taking them to the highest level in seventeen- years .

I am most grateful to my veteran subscribers and to my many new ones. I know that in a time of recession, universal gloom and shattering losses, a check for $95 for an investment service is not an easy thing to part with. I hope that some of the market losses that were avoided (if you followed my advice) more than make up for the cost of a subscription. At any rate, I find that I am sweating just as much this year as last . And that isn’t because of the increased subscription list, it’s because Wall Street isn’t getting any easier (or perhaps I’m not getting any smarter) .

On to the market : Turning to the long chart on page 1, let’s see what is happening to the various indices and averages which we are using to measure the depth (or the death) of the great bear. On December 13 and again on December 16 the Primary Trend Index or PTI (which is my own composite of eight critical indices and averages) recorded brand new bear market lows. On December 16 the advance-decline ratio for the NYSE recorded another bear market low. But note that none of the Averages, our gauges of the actual price movement, have confirmed on the downside .

As a rule, the longer a primary trend is in force, the less the significance of preceding points in the Averages. Thus, I show a bear market low of 116. 69 in 1970 for the D-J Transports.

Four years have elapsed since that low, and I therefore do not accord too much importance to that earlier low. However, the Transports struck a low of 125.93 on October 3, 1974 . One day later (Oct 4) the Industrials touched a low of 584. 56 . On December 6 Industrials broke to a new bear market low of 577. 60 (see page 1 chart) . Transports have not yet confirmed . This could prove to be very significant . Time will tell. Also on the significant list is the fact that so far, the D-J Utilities, the D-J Bonds and the S S P 500 Average have refused to confirm the December 6 low on the Dow. The longer this condition prevails, the more hopeful the overall picture for the market in general .

Question : Russell, are you saying that we could have seen a major bear market bottom? Answer: I’m saying that it is possible, that I now feel better than 50/50 about it. Frankly, there are a number of phenomena I would like to see, but as I have said so often, they don’t run the market for Richard Russell . For instance, I would like to see much more odd-lot shorting, I would like to see more skepticism on the part of advisories concerning the periodic rallies . I would like to see even blacker sentiment (regarding securities) than we now see . I would like to see the Averages form a dragging, low-volume bottom . I would like to see stocks act totally immune to bad news (although they still get hit somewhat when bad news emerges) .

Question : Russell, I want to pin you down. Do you think we have seen the bottom? Answer : You’re asking me a question that I have no right to answer at this time. Remember, after eight years of “promising” my readers that the market was most definitely going lower, I have now decided to let the market show me that it is or is not going lower. Second point : All bear market bottoms are identified in retrospect (except by those geniuses who call the “bear market bottom” all the way down, and who, like the clock that stopped, are eventually correct) .

Subscribers should remember too that it is not necessary to pin-point the ultimate bottom of a bear market .The bottom could be here, it could arrive in a week, a month or six months. We have been in the third phase of the bear market . When the Averages produce a primary bull signal or when our moving averages of the Dow and our Dow momentum turn up, we will know that the tide has turned.

Question : What would a Dow Theory bull signal entail at this point? Answer : The last joint laws in the Averages were recorded October 3 and 4 (see chart 4). Next we had -a rally to the November 4 Industrial peak of 674.75 and the . November 6 Transport peak of 156. 61. A new decline of secondary proportions took Industrials to the recent December 6 low of 577 . 60 . The same decline took Transports to a December 16 low of 138 .31 .

If any forthcoming advance (and we are now in one) succeeds in taking the two Averages above their November peaks (Industrials 674.75, Transports 156 . 61 ) I am going to call a new primary bull market . It’s as simple as that .

Question : What do we do if that happens, Russell? Answer : If we get a bull signal, neither I nor any one else on the face of the globe knows how extensive the bull market will be or how long it will last . It could be a five-year whopper or it could be a one-year disappointment (or a one-year explosion for that matter) .

At any rate, if we get a bull signal I would recommend moving 25% of your funds into a no-load (no commission) mutual fund as the first move. Individual stocks will then be discussed as we move along. But as to the fund, it should be one that has a good record of performing in an “up market, ” and I will leave this to you and your broker. (If you haven’t got a competent and knowledgeable broker by now, this is the time to get one). I might add that Growth Fund Guide, PO Box 2109, San Clemente, CA 92672, ($39 annually) contains invaluable research on the “growth funds” .

Question: Suppose one or both of the Averages refuse to better the 674.75 (Industrial) and 156 . 61 (Transport) high of November, 1974 and they then turn down and break to new bear market lows? Answer: If that happens, we’re still in the bear market’s third phase.

Question : What about buying some stocks now? Is it necessary to get proof of a new bull market before buying? Answer : Nothing in . Dow’s Theory states that it is necessary to wait for a Dow Theory bull signal before buying .
The bull signal represents technical confirmation that we were correct - that a bear market bottom indeed did occur.

Now this is how I view it . I think the odds are probably better than 50/ 50 that the Dow and most shares hit a bottom in December, 1974. I put this thesis together with a number of other facts. As you will see in a later section, the unweighted NYSE average is now down around 77% from the high. In 1929-32 the unweighted NYSE average went 12% further on the downside - to an 89% loss. I feel that most shares have now discounted all the forthcoming bad news, and I am including recession-depression conditions in 1975 . We have been in the third phase of a great primary bear market .We are finally in the zone of “great values” . In many cases, stocks are selling “below known values” . Here’s an interesting statistic : The price/ earnings ratio for the 30-Dow Industrials is now around 6. 0 while the yield on the Dow is 6.36. This means that the Dow P/E is below the yield on the Dow . This happened only once before in the last forty years, and that was during 1948-50.

Second item: The Dow is now selling below its book (or break-up) value . This has not occurred since 1942. Are these two above Dow “tests” infallible indications of the final bottom? Not at all, but they do indicate that the Dow is sure getting down there .

Last week Value Line ran a very clever advertisement. They listed 18 NYSE stocks including such issues as Telex, Ampex, Pan Am, Lockheed, General Steel, Avco, Lear Siegler, United Brands, etc . - eighteen of them. “At their pre-1971 highs, the average price . per share for any ONE of these stocks worked out to $50. Today, ” said Value Lines, “you could buy ALL 18 for less than $50. ~~ I read the ad and I said to myself, “Value Line is talking values . I can’t argue with that ad .”

Many readers may remember the median price study from Letter 599 (a study that I keep abreast of courtesy of Prof. S . L. Davis, Case Western Reserve University) . This study shows the median price of all stocks on the NYSE or the middle price . The median price is now 12 .3, a fraction off its 1974 low of 12 .2 . This means that half of the stocks on the NYSE are currently priced below 12 .2 and half above 12 . 2 . The lowest point since 1920 for the median was the 7 . 0 of July 9, 1932.

All right, I’ve talked about values.The fact is that a very long list of good stocks have lost 75% to 90% of their value. I do not see anything wrong with beginning accumulation inthese shares now. I think the downside risk in these shares is very limited . I think a package of five or preferably ten or more of these issues should work out well in the period ahead. I think that even if the Dow breaks again to the tune of another 100 points, these stocks would tend to hold.

Here is a representative list of stocks that I personally like, get your broker on them to find out dividends, earnings, etc . (This is your chance to get your broker to move his fanny!) . G. D. Searle. Bell & Howell, Reynolds Metals, Uniroyal, Coca Cola of NY, McGraw Hill, Holiday Inns, Kaiser Cement, Food Fair, Fairchild Industries, Clorox, Miles Laboratory, Cluett Peabody, Spring Mills, Woolworth, General Host, Faberge, Macy’s, Miles Laboratory, Pennzoil, Texaco.

Question : Russell, how is it that you don’t recommend putting all of your assets into the market on a bull signal? Why not get fully invested? Answer : If you remember, I said in the last Letter that a true bear market goes throughintense deflation and liquidation, not only in the stock market (which has already occurred) but in the economy (and this has not occurred) . I said that if this economy did not go through the big liquidation, then any bull market that developed could be sub-standard in duration and extent. I feel that a bull market which materialized in this area could be a sort of “abbreviated bull” . Therefore, with subscribers still holding 25% in gold items and putting another perhaps 15% to 20% in some of the issues listed above, and finally placing 25% of remaining funds into a no-load fund (on a primary bull signal), I feel we would be in the correct stance . This stance would allow us to gain from ‘a bull market that would almost surely be fueled by a new round of monetary inflation (rather than a bull market that grew out of a natural foundation of intense liquidation and real, pent-up demand) .

Question : Russell, what about the panic for cash and the profit collapse which you foresaw for 1975? Answer: They may well be coming, and today’s prices may have discounted them. But I never argue with the market, and the fact is that the last confirmed lows in the Averages were made on October 3 and 4 (Industrials 584. 56. Transports 125 . 93) . Both Averages have not been lower since . Industrials have been lower, but that constituted a non-confirmation .

The extent of the damage brought in by the bear market is shown in this chart by Trade Levels, 301 E . Colo. Blvd., Pasadena CA 91101 .This unweighted chart shows the disastrous story of the last number of years . There’s been only one worse collapse in Wall Street history.

The 1-2-3 notations should be clear to all who followed my earlier discussion of the Elliott Wave Principle . Bear markets come in major 1-2-3 waves. According to the chart, this major downward zig-zag could be completed .

Question : What about the gold shares and gold coins, what do we do with them? Answer : My gold share/bullion ratio chart broke up last week in favor of the metal (coins) over the shares (see chart, last Letter) . I consider the coins to be a survival hedge, our treasure trove of real, honest-to-God money. The shares should be held for what looks like a move coming up into the first quarter . At that point I will have to make a decision on where we stand with the gold shares . At this point, I would say that the downside for gold shares has been well tested, and that they should be held as a leveraged hedge against what could be coming up in 1975-76, namely, the biggest spate of monetary inflation yet (the December Bank Credit Analyst states that it could take a 20% to 25% expansion of the money supply to move the economy out of this gathering recession) . A thought: What happens if the 2 million ounces of gold that the Treasury is “auctioning off in January is gobbled up? I would say that such action would constitute a big plus for gold (already it is rumored that the Arabs may take the whole batch) .

Dow 1000: Finally in ‘72
Cheers rang out on the floor of the New York Stock Exchange when the Dow Jones Industrial Average crossed the 1000 mark on Nov. 14, 1972.

If ever there was a psychological barrier for the Dow industrials, ”Dow 1000” was it. The average had knocked on the door of 1000 repeatedly for six years, but could never close above that ”magic” level.

For example, the industrials closed at 995.15 on Feb. 9, 1966, and at 985.21 on Dec. 3, 1968. There were also close calls in May 1969. But no cigar — until the euphoria of 1972.

Many investors active today will remember 1972. Richard Nixon was president, ”The Godfather” was packing them in at the movies, and Americans were tuned to ”All in the Family” on television. The Watergate scandal, which later destroyed the Nixon administration, was only a cloud on the horizon. The Vietnam War was a major problem, but on the day the 1000 barrier fell, North Vietnam had agreed that its representative would meet with U.S. negotiator Henry Kissinger for a new round of talks aimed at ending the war.

The re-election of Mr. Nixon over George McGovern had occurred a week earlier. And the economy was doing well. Economic growth was unusually strong, inflation was moderate and interest rates were low.

In the stock market, it was the heyday of the ”Nifty Fifty,” stocks that were so popular that it was said they were ”one decision” stocks: Buy them, and never worry about selling. Among the most popular stocks of the day were Xerox, Avon, IBM and McDonald’s.

Not long after the industrial average punctured the 1000 mark, a recession occurred and the brutal bear market of 1973-74 set in, pushing the average all the way down to 577.60 in December 1974. It would be late 1982 — a full decade after the 1000 milestone was first passed– before the industrials rose above 1000 to stay.

 

Dow Jones Theory 1932

Robert Rhea was a pioneering figure in the history of Dow Theory. Rhea was a master of “reading” the stock averages along with volume implications. Rhea started his great investment service in 1932. He modestly called his service, “Dow Theory Comment.” Rhea’s Dow Theory “voyage” ended with his death in 1939.

Rhea had a private following of investors, and this group kept in contact with Rhea through a single stockbroker. Rhea writes, “On July 21 when the Industrials closed at 46.50 and the Rails at 16.76, I asked my broker to tell my friends trading in various offices that I thought the Dow Theory implied heavy buying for the first time in over three years. On July 26, 1932, the opinion below was sent to perhaps fifty correspondents.”

Russell Comment - I include below the opinion that Robert Rhea sent to his correspondents on July 26, 1932. This was sent just a few weeks after the final bottom of the worst bear market in US history. I consider it one of the greatest calls in stock market history.

Robert Rhea Calls the Turn

The declines of both Rail and Industrial averages between early March and midsummer were without precedent. The thirty-five year record of the averages shows a fairly uniform recovery after every major primary action, and such recoveries average around 50% of the ground lost on the decline; are seldom less than a third and more than two thirds. Such recovery periods tend to run to about 40 days, but are sometimes only three weeks – and occasionally three months.

The time element is in favor of a normal reaction at this time – because the slide off was normal (the normal time interval of major declines being about 100 days).

The market gave the unusual picture of hovering near the lows for more than seven weeks, and might be said to have made a “line” during the latter weeks of that period.

Because of all these things, and because the volume tended to diminish on recessions and increase on rallies during the ten days preceding July 21, almost any one trading on the Dow Theory would have bought stocks on July 19th. Those who did not, had a clean cut signal again on the 21st. Since that date the implications of the averages have been uniformly bullish, and it is reasonable to expect that a normal secondary will be completed, even though the primary trend may not have changed to “bull”. So much for the speculative viewpoint.

However, the investor asks, “Have we seen the lows for the bear market?” According to strict construction of Dow Theory, we cannot yet tell.

Surely we have many things which might lead us to believe this to be true – we have surely had a considerable period of accumulation, but these periods frequently preface secondary reactions, or occur at some intermediate point in a secondary. Should this secondary reach normal limits with respect to recovery and duration, and a decline of some weeks follow, and this decline did not break the bear market lows, after which a recovery set in which carried above the high point of the secondary now in the making, it would seem reasonable to suppose that the lows had been passed. And should the secondary now forming develop a sideways drag beneath normal expected recovery points, making a clearly defined “line”, and should such line be broken topside with some healthy advances, it

would be a splendid buying signal.

Robert Rhea
July 25, 1932

Volatile Stocks Marked the ’30s
Most investors know that the Dow Jones Industrial Average did miserably during the Depression of the 1930s. It began the decade at 248.48, down from a high of 381.17 before the crash of 1929. By July 1932, the depths of the Depression, the industrial average was crawling at 41.22. It ended 1939 at 150.24.

What many investors don’t know is that the 1930s were also the most volatile decade on record for stock prices. Investors, their nerves rubbed raw by the Depression, were prone to fits of euphoria and despair.

Thus, the industrial average plunged 52.7% in 1931 and 32.8% in 1937, but it rose 66.7% in 1933 and 38.5% in 1935. Daily volatility was also intense. Strange as it may seem, seven of the 10 biggest up days in history, on a percentage basis, occurred during the 1930s.

Franklin Delano Roosevelt took office in 1933, instituted social programs and put people to work building roads and public buildings. The history of his administration could serve as a political Rorschach test. Peering at the inky lines, some see Demon Roosevelt, others Savior Roosevelt.

The stock market generally seemed to like FDR’s measures. The Dow industrials rose 39 points in 1933, 6 points in 1934, 40 points in 1935 and 36 points in 1936.

Richard J. Stillman, professor emeritus at the University of New Orleans, said in an interview in 1996 that the launch of the Civilian Conservation Corps, the Securities and Exchange Commission and Social Security helped turn the Dow around.

However, the late Robert Sobel, a professor of business history at Hofstra University on New York’s Long Island, disagreed. The market was rebounding anyway, and the New Deal provided a psychological, not an economic, boost, he argued.

By 1938 the Dow had fallen below 100 again. Mr. Sobel blamed Mr. Roosevelt, for raising taxes. Mr. Stillman said overseas demand for U.S. goods was weak, as other countries were embroiled in their own miseries. The two historians agreed that World War II was the spark that finally ended the agony. Said Mr. Sobel: ”The war took the country out of the Depression, not Roosevelt.”

 

Richard Russell’s Dow Theory analysis questioned

There has been an interesting response [rebuttal] of Richard Russell’s claim in Barrons over the weekend with regard to the accuracy of his claimed analysis.

ANNANDALE, Va. (MarketWatch) — More than a few eyebrows were raised this past weekend by an article in Barron’s by Richard Russell.

Russell, of course, is editor of the Dow Theory Letters newsletter. He has been editing this service since 1958, which is longer than any other newsletter editor still publishing today.

In his article, entitled “A Rally With Serious Muscle,” Russell argued that, not only are we in a bull market right now and that “new highs are coming,” but also that “the great bull market that began in the early 1980s is still intact.”

Those are headline-grabbing pronouncements, to be sure. But I don’t think that they were what raised the most eyebrows. After all, he has been saying much the same thing for several weeks now. ( Read my April 9 column.)

Instead, what caught many investors’ attention was the following Russell sentence: “Interestingly, at the 2002 low… I believed the bull market was still in its ‘expensive’ and speculative phase, and that there would be a major recovery, with probable new highs.”

Oh yeah? That certainly wasn’t my recollection of what he was saying at the time.

To determine whether my recollection was right, I went digging through the Hulbert Financial Digest archives, which contain copies of all of Russell’s daily postings on his website.

My hunch was right.

Throughout 2002, in fact, Russell consistently argued that the primary trend of the market was down. And far from giving bullish noises on October 9, 2002, the day of the low, Russell argued that the bear market was very much alive and well.

For example, after the close on that day, he wrote to subscribers: The Transports broke below its September 2001 low today. In doing so, it confirmed the prior bearish action of the Industrials. Under Dow Theory, the twin penetrations reconfirm the primary bear trend. The bear market is still very much in force.”

Russell furthermore went on to predict that the bear market he was envisioning wasn’t going to be just a minor decline, either. “This is a Big Poppa bear market,” he wrote.

Nor did Russell change his mind in the ensuing weeks. At the end of 2002, for example, when the Dow Jones Industrial Average was more than a thousand points higher than where it stood at its October 9 low, Russell took issue with those who thought the bear market was over:

“Bear markets have always ended one way — in exhaustion. Exhaustion is characterized by black bearishness, usually low volume, and great values in blue chip stocks (the market for secondary stocks almost ceases to exist). So let me put it gently, we’re not there yet… This bear market has followed the greatest, the longest, and the most wildly speculative bull market in history. It’s illogical to believe that this bear market has ended after erasing only 38 percent off the peak price of the Dow.”

It would be easy to conclude that Russell simply took liberties with the truth in order to make him look better. But what makes his case interesting is the possibility that Russell actually believes what he wrote in this week’s Barron’s.

I say this because our memories play tricks with us all the time. Selective memory is not the exception, but the rule - and not just when it comes to investing, but in all walks of life. Just ask my wife, who is a clinical psychologist.

This is why it is so important that we submit our memories to a reality check. If someone as distinguished as Richard Russell, and as close a student of the market as he is, can engage in rewriting history, then it should serve as a warning that we could easily succumb to the practice ourselves.

Notice, by the way, that you don’t become immune to rewriting history just by having a good track record. After all, Russell’s market timing performance puts him in the upper echelons of the market timing newsletters the HFD has tracked since 1980.

Of the many reasons to be accurate historians of the past records of both ourselves and various advisers, one of the more important is to develop realistic expectations. If, after reading Russell’s article, you were to mistakenly believe that by following him you would have been bullish on the exact day of the bear market’s bottom, you’d have unrealistic expectations about what Russell — or any market timer, for that matter — could do for you in the future. By thinking that near perfection is available, you’d be likely to prematurely stop following your market timer.

That could end up costing you, since long-term success when following an adviser is dependent on not getting rid of him at the first sign of trouble. Instead, you need to stick with him long enough for him to actually be able to produce decent returns.

 

Dow Theory…1942

Many Characteristics of the First Phase of a Bull
Market Are Present at This Time

By Justin F. Barbour

The characteristics of the market are those of the beginning of a change in major trend. These characteristics are the market’s seeming immunity to the news; the extreme low volume of trading for many months; and the in-gear advance that is developing in the averages. These are significant symptoms because they are occurring after a bear market has run a very long time and after two periods of marked divergence in the movements of the averages. In addition to expecting a bull market to set in after many months of constant unfavorable news and decline, one should expect a bull market to develop in the war period because it is the history of war periods here and abroad.

The movements of the market are susceptible to wide analysis. In addition to extent and duration, movements can be judged by their characteristics and phases. The initial phase of a major move - bull or bear – develops at an extreme and invariably at a time when the prevailing news is in decided conflict to the new move.

The second phase coincides with the recognition of the new move and the visibility of developments justifying it. The confirmation of the change in major trend usually marks the division between the first and second phases. The third phase is the period of universal recognition of both the major trend and the conditions responsible for it. It is usually a period of increasing volume and the time when one feels confident in as well as the desire to participate in and profit from the established trend.

It is easy to apply these phases to the markets of the past. The first phase of the bear market was present in the Fall of 1939 when business, earnings and dividends were increasing because of the war in Europe. At the time it was hard to understand why the averages failed to continue their advance in the face of such economic conditions. The second phase came with the invasion of the low countries and the panic decline in mid-May, 1940.

The second phase continued until the surprise attack on us at Pearl Harbor brought us both into the war and the beginning of a complete war economy. It was at this point that the third and final phase of the bear market set in, the period in which so many developments – adversity, priorities, price ceilings, rationing and taxation – made it so easy to justify the sale of securities.

In the transitory period, there may be an overlapping of the third or final phase of one major movement and the first phase of the next major move. While temporarily there may be a question as to the point at which the third phase ends and the first phase begins, in the current instance it can be said that the bear market has been in its third and final phase a long time and that the characteristics of the first phase of a bull market are present.

Conditions of Change

These characteristics as before mentioned are: (1) an extreme point – the lowest in many years; (2) the seeming immunity of the market to the prevailing news; (3) the extreme low volume of trading; and (4) the in-gear advance that is developing in the averages.

On April 28 the industrial average was at its lowest point in seven years; the rail average close to the low of two years and in the low area of nine years. One group, the utilities, was at their lowest point of record. An extreme, out of which the first phase develops was and is present.

For at least two weeks the market has appeared to be immune to very depressing news. Except for the initial day of decline the averages have moved sidewise and advanced in the face of a major military defeat. Neither dividend reductions nor the proposed tax bill appear to depress stocks now. Demand prevails where the impulse is to sell.

Volume is very low and is characteristic of completed moves. The tendency of volume is to expand as moves gain momentum and become obvious, and to contract when they have exhausted themselves. Peak volume since the bear market set in, as measured by a five weeks average, was 1,392,000 shares daily, reached in the panic decline of May 1940. This peak was closely approached last December as a result of the combination of selling generated by the Jap attack on Pearl Harbor and year end tax selling.

The lowest average volume in a generation was 272,666 shares daily. For 20 weeks daily volume has not averaged 400,000 shares. Half of this time the average has been under 300,000 shares. Volume is and has been at a low extreme for months. Neither the decline of this year nor unfavorable news has developed sizeable nor increasingly sustained volume. The inference is that liquidation has run its course and that the final phase of the major decline has been completed.

Conditional upon the industrial and rail averages holding above their recent lows of 92.92 and 23.31, there is ample justification to presume that a bear market has been completed and that a bull market has set in. The breaking of these lows by both averages will invalidate this presumption; the plotting of the three movements previously described will confirm it. Written as of July 3, 1942. Industrial average, 104.49; rail average, 25.02.

Justin Barbour

Hitler and the Panic of 1940

During World War II, The Dow Jones Industrial Average took two strong hits that kept it in a slump through most of the war.

The first was in early 1940, when Adolf Hitler’s armies were on the march. The alarm caused by his aggression sent the Dow Jones Industrial Average into one of the steepest tailspins in its history as it fell more than 23% in just two weeks.

From a monthly high of 148.17 on May 9, the average fell to 113.94 on May 24. The market, which had been strong, turned nervous after the Nazi army invaded Denmark and Norway in April 1940, several months after Germany had overwhelmed Poland. The Wall Street Journal noted that ”the current stock market is well-charged with psychological dynamite.”

On May 9, the Journal wrote that an invasion of Holland ”would awaken fears that England was about to be attacked.” The next day Hitler’s armies swarmed into the Low Countries of Holland, Belgium and Luxembourg, and were on their way to a quick victory in France.

In the middle of the decline, The Journal’s Abreast of the Market column reported that ”while numerous practical-minded individuals in Wall Street take the view that more intense warfare will be stimulating to our industries . . . they recognize the dangers inherent in a swift German victory.”

By June 11, after the German invasion of France was under way and the British had been forced to abandon their defense of northwestern France and Belgium at historic Dunkirk, the Dow changed course and stayed largely on an upward trend for the remainder of the year.

”Once the intial shock of the fall of the Maginot Line was over, you had a recovery,” said the late Robert Sobel, a historian at Hofstra University. Economic historian Richard Sylla of New York University added that as the battle of Britain was waged, it became clearer that the Royal Air Force would be able to defend Britain, so American investors felt ”they weren’t going to wake up the next day and find that Britain had fallen.”

However, more than one year later the war took on a far more personal tone and sent the stock market on a long-term descent.

On Dec. 7, 1941, Japanese planes bombed the U.S. naval base at Pearl Harbor in Hawaii, dragging the U.S. into World War II.

President Franklin D. Roosevelt called it ”a date which will live in infamy,” and the stock market certainly agreed. The Dow Jones Industrial Average fell 3.5% on Dec. 8, to a 112.52 close from 116.60, and stayed on a downward trend for five months.

Until Pearl Harbor, many Americans hoped the U.S. would avoid direct military involvement in World War II. But the Japanese attack made that impossible.

The attack, which took U.S. forces by surprise, also took the stock market by surprise. Here’s how The Wall Street Journal’s Abreast of the Market column described the situation: ”The outbreak of hostilities between Japan and the United States came after the close of a week in which stocks had scored the most vigorous advances witnessed in several months. While tension existed in U.S.-Japanese relations, the Street had felt that negotiations between Tokyo and Washington were likely to proceed for some time before the matter came to a head.”

One of the market’s big worries was how the war would be financed. It was obvious that the Roosevelt administration would have to raise taxes, borrow heavily or both. This unpleasant situation was described in the Journal as a ‘’shadow . . . overhanging the landscape.”

On the plus side, however, the U.S. entrance into the war meant ”reshaping the productive machine to assure maximum output for the enemy’s defeat,” as the Journal put it in a front-page article. Some economists believe it was the war effort that finally pulled the U.S. out of the economic doldrums that began in the early 1930s.

The industrial average continued to drift down until it hit bottom in late April 1942 at 92.92. Then it began to recover and chug upward. By year-end 1942 it was at 119.40, and by the end of 1945, the year the war ended, it stood at 192.91. Over the years, that pattern-an initial drop, followed by a rebound-has been the typical pattern when the U.S. gets involved in military conflicts.

 

Dow Theory…1949 analysis

Prior to conducting an analysis utilising Dow Theory, let’s look at an example from history [1 of 4]

Saturday, June 18, 1949

MARKET PSYCHOLOGY － When the consensus of opinion among the ‘crowd’ has reached the point where it confidently expects the stock market to decline; market psychology suggests that the bottom of the bear market may not be far away. On Monday and Tuesday of the past week a most bearish market psychology prevailed among the trading public as the low closes of the past 2½ year’s trading range was violated. Short selling became quite popular as those positions were precariously extended on the occasion. A rapid deterioration of any remaining bullish confidence was evident as the bears exuberantly predicted considerably lower prices for the market place. Statements such as, ‘You haven’t seen anything yet’, and ‘You will be able to buy them at half the price’ were frequently heard in brokerage rooms. These are manifestations representing the most depressed psychology of a bear market. The lowest ebb of investment confidence among the public is always apparent at the lowest points in bear markets.

When the trading public becomes certain that the stock market will decline, astute traders and investors will regard this as a bullish symptom for the future trend of stocks. Exactly the reverse was true one year ago, when the cycle reached its opposite extreme and a feeling of certainty existed that the market would continue to advance. Market history is filled with instances where the ‘crowd’ became bearish at the bottom and bullish on top. The present case is, we believe, no exception. The bear market has reached a stage where an overwhelmingly bearish psychological condition is at hand. Based on precedent, the present situation warrants close observance for a turning point in the market.

The intensity of the situation is reflected in the over-crowded short interest that present-day short sellers are confidently ignoring. When the latest short interest total is published within the next few days, it will probably represent the largest since 1932, when one of the worst depressions in the nation’s history was at hand. An abnormally large short interest has always served to electrify swift and large advances in the stock market, and the present case will be no exception. The longer the downtrend persists with an increase in total short positions, the more sensational will be the advance when it finally materializes.

BULLISH FACTORS ─ During the past three years, market swings have been relatively narrow, and, under the Dow Theory, three changes in primary trend have occurred. A bear primary trend was in effect from May-June, 1946, to May, 1947. A bull classification was given the primary trend from May, 1947, to June-July, 1948. At the present time, another primary bear trend has been under way since the highs of June-July, 1948. Each of the first two primary trends were of approximately one year’s duration, and the present primary bear trend is again at the one-year mark. If the current bear market is to correct only those excesses which occurred in the preceding bull market, a sufficient correction in both time and extent have already been made. This factor favors another change from bear to bull in the primary trend in the near future.

Up to this writing, the market has not penetrated the intra-day lows of its 2¥-year trading range. Until a decisive breakout of this area occurs, the averages could advance and test the upper limits of the area, or continue to fluctuate within that range for an extended period of time. The industrial average established an intra-day low of 160.49 in October, 1946, and the rail average recorded its extreme intra-day low of 40.43 in May, 1947. These lows were closely approached by both averages during the past week, but were not violated. On Tuesday, the extreme intra-day lows of the current bear market were recorded at 160.62 and 40.88. A slight decrease in volume was noted at the lows, while odd-lot short sale orders skyrocketed to 121 on the very low day. The fact that the market refused to give a decisive downside penetration of its long 2¥-year trading area implies that a rally from those lows will develop after a sufficient test of those lows has been made.

Another bullish tinge was given the market by the appearance of a ‘gap’ of .24 in the industrial average on the downside on Monday. The possibility appears that this might have been an ‘exhaustion gap’, indicating that the market is becoming exhausted on the downside from its prolonged decline since March 30. More often than not, a gap occurring after a long decline signifies the end of that decline is near, and that an advance in the averages will follow.

An increasingly bullish factor in recent statistics has been the trend toward higher yields. At the intra-day lows of the past week, the 30 Dow-Jones industrials showed an average yield of 6.91%, while the 20 Dow-Jones rail stocks showed 9.12%. These high yields are approaching the extreme highs in yields recorded on only three other occasions during the past 17 years. The bear market lows of 1932, 1938, and 1942 were accompanied by peak yields in the Dow-Jones industrials of 10.38%, 8.07%, and 7.97%, respectively. A declining tendency in these peaks is noted, and, therefore, the current 6.91% peak may be in close proximity to the peak to be established in this bear market. A declining tendency has also been in effect for yields at the top of bull markets. In the bull markets which culminated in 1937, 1938, and 1946, the Dow-Jones industrials yielded 3.70%, 3.44%, and 3.23%, respectively.

CONCLUSIONS － The philosophy of Charles H. Dow always gave first consideration to values, then to economic conditions, and third, to the action of both the industrial and rail averages. When the low point of a bear market is being approached, values will give us the first indication of a change in trend. In the past 17 years only three opportunities presented themselves to buy stocks at great values, and now the fourth opportunity is making its appearance. We continue to regard stocks as having entered a ‘buying area’ on a basis of values. Good dividend paying issues should be purchased during periods of market weakness, and held until such time as yields for the industrial average are back into the 3% to 3½ % area. Once stocks are purchased, both the minor and secondary movements in the market should be completely disregarded. A new period of prosperity will follow, once the present recession has run its full course. From present indications, the current business recession will continue until later this year and possibly into 1950. Following that a two-to-five year period of prosperity will be sparked by a good foreign trade situation and by strong activity in the building and automotive industries. Television and other new industries will continue to flourish, and confidence will be placed in the stock market as it climbs back to a point where yields are close to the 3% point again. Based on present prices, earnings, and yields in the senior average, computations indicate that the eventual highs of the next bull market will be recorded in the 325 to 375 area.

Dow Reacted Grimly to War

The outbreak of the Korean War sent the Dow Jones Industrial Average into a tailspin.

North Korean forces attacked South Korea on June 25, 1950. The industrial average had begun to decline three days earlier, on June 22.

The confrontation had been building since Korea was split along the 38th parallel after World War II. The North fell under the influence of the Soviet Union, the South under the watch of the U.S.

When the 38th parallel was crossed, the U.S. seemed uncertain how to respond. In just under three weeks, the industrial average fell 12%, to 197.46 on July 13.

By July, Gen. Douglas MacArthur had taken command of the United Nations forces assisting the South Koreans, and military supplies were being shipped to the troops. As Gen. MacArthur’s victories mounted and his men marched northward, so did the Dow. The industrial average ended the year up 17.6%, and tacked on another 14.4% in 1951.

”The Korean War was a good period for the Dow, but not necessarily all due to the War,” says historian Richard Sylla of New York University. ”The defense stocks did very well, and the rails did even better because a lot of supplies needed to be transported.”

The Dow industrials dipped again later in 1950, when Chinese forces entered the war on North Korea’s side. Fighting continued into 1951 with little hope of a military victory for either side.

Disagreements over U.S. policy toward China spurred President Truman to fire Gen. MacArthur in April 1951. The stock market rose on the news, reflecting the reluctance of Americans to risk a war with China and potentially the U.S.S.R., according to Professor Sylla.

A truce in July 1953 ended the fighting, after 33,651 American soldiers had died. The following year, 1954, the Dow finally reached and passed the levels it had attained before the great crash of 1929.

Dow Cruised to 500 in Nifty ’50s

It took a quarter century for the Dow Jones Industrial Average to crawl from 300 to 400. But in little more than a year, the average sped through the next barrier, 500.

The 500 milestone was reached on March 12, 1956. It was one manifestation of the power in the long-lasting stock-market rally of the 1950s. Until recently, the decade was the best ever for the industrial average, which climbed 239.5% from 1950 to 1959.

Low inflation and low interest rates provided an ideal environment in which stocks to thrive. The spanking new Interstate highway system helped zip goods from place to place, and the new medium of television helped to create an appetite for those goods. President Eisenhower was popular, and the country, for the most part, was in a good mood.

Jeffrey Rubin, director of research at Birinyi Associates in Greenwich, Conn., says that good news about Mr. Eisenhower’s health was important in propelling the Dow industrials to a strong month in March 1956. The president had suffered a heart attack the previous fall, and people were wondering whether he would run for re-election. In February, Ike announced that he would, indeed, run.

The 500 level was breached on a day when the headlines told Americans about not just one, but two international crises. In the Middle East, tensions were running high between Egypt and Israel. The situation would erupt into outright warfare later that year during the Suez crisis. Meanwhile, in Cyprus, a general strike was under way, protesting Britain’s deportation of Archbishop Makarios, who had led a movement to unite Cyprus with Greece.

Such crises often spook the stock market, at least for a short time. But in March 1956, the bull market shrugged them off.

Some investors active today will remember 1956. DeSoto was still a popular car. ”Hound Dog,” by Elvis Presley, was a red-hot hit song. In baseball, Mickey Mantle was the most valuable player in the American League. And on television, Robert Young was starring in ”Father Knows Best.”

Sputnik Launch Spooked Stocks
The space shot that launched mankind’s first Earth-orbiting satellite on Oct. 4, 1957, was achieved by the Soviet Union, at the time the archenemy of the U.S. As a result, it was a shot that wounded the U.S. stock market.

The Dow Jones Industrial Average stood at 465.82 on Oct. 3, 1957, the day before Sputnik was launched. By Oct. 22, it had fallen to 419.79, a nearly 10% drop in just three weeks. A feeble recovery ensued, but at year end, the industrials remained 30 points below their early-October level.

The selling reflected decreased confidence among U.S. investors as the Soviets seemed to have captured the technological lead in the space race — and, people feared, in other areas too.

But the selling wasn’t across the board. Aircraft and missile stocks showed some strength, as investors surmised that the U.S. would commit greater resources to those industries. As the Journal’s Abreast of the Market column put it, ‘’some of the aircraft stocks [were] lifted by the Soviet moon.”

On Oct. 10, 1957, the Dow industrials fell 9.69 points, the biggest decline stocks had suffered since President Eisenhower’s 1955 heart attack jolted the market two years before. That drop also left the industrials at their lowest point in two years.

Then, on Oct. 21, the stocks took an even worse tumble, with a 10.77-point decline. Brokers and traders blamed the drop partly on U.S. government complacency in the wake of Sputnik; the Pentagon announced plans to cut aircraft procurement, which struck many people as unwise, given the technological prowess the Soviets had just displayed.

Tensions between Syria and Turkey also contributed to the October 1957 declines. Not until May 1958 did the Dow industrials climb back to their pre-Sputnik level.

While fears that the U.S. was losing its technological pre-eminence sparked the post-Sputnik decline, the opposite has been happening lately. Increasing confidence that U.S. companies are the world’s technology leaders has fueled the strong stock-market performance of the 1990s

 

Dow Theory…an introduction

In Barrons this weekend, there was an article based on Dow Theory that in essence stated that the bear market in 2000-2003 was a correction, based on the fact that the DJIA did not fall below a 50% retracement [I assume the Transports had a similar pattern]

Therefore, the great Bull Market of 1982, in in point of fact still intact. If this is the case, we should expect a retest of the highs, and continuation to new highs.

Here is some historical background on the origins of Dow Theory, written by Richard Russell, arch advocate and practitioner;

DOW’S THEORY: From the very beginning, July 1958 I called my report Dow Theory Letters, and there are obvious reasons for that. The reasons are (1) I truly believe in the basic tenets of Dow Theory, and (2) I wanted to teach Dow Theory and I wanted to insure that the Dow Theory tenets, rules and observations were passed on to future generations.

Before I start this section let me say that there are hundreds of predictive and trend-following techniques that are now used (some very worthwhile, others less so) by market students. I follow dozens of these techniques and devices, but none of them will ever replace or negate the basic tenets of Dow Theory.

I’ve been writing these reports for 41 years and never a month goes by that someone doesn’t announce that the Dow Theory is antiquated and that it no longer works. The detractors, almost to a man, do not know their subject and have, in almost all cases, never studied Dow Theory. The Dow Theory (actually it is a set of observations) has basically to do with buying great values and selling those values when they become overpriced.

Value is the operative word in Dow Theory. All other Dow Theory considerations are secondary to the value thesis. Therefore, price action, support lines, resistance, confirmations, divergence — all are of much less importance than value considerations, although critics of the Theory seem totally unaware of that fact.

I’ve spent two-thirds of my life studying and writing about the markets. And I’d say that without a shadow of a doubt the material which has served me best are the books and papers written by the great Dow Theorists — Charles H. Dow, William P. Hamilton, Robert Rhea and E. George Schaefer.

First, let’s talk about Charles Dow, a man who, by any reckoning, must be considered a brilliant market observer and theorist. Dow started his career as an investigative reporter, specializing in business and finance. In 1885 (and few people are aware of this), Dow became a member of the New York Stock Exchange, and this provided him with an intimate knowledge of how the market works. In 1889 Dow began publishing a little newspaper which he called The Wall Street Journal. Between 1899 and 1902 Dow wrote a series of editorials for his Journal, editorials that many consider among the finest ever to come out of Wall Street. Written almost 100 years ago, these editorials are as pertinent and valuable today as they were the day they were written.

Dow was a very modest man, and although his admirers begged him to write a book explaining his theories, Dow stubbornly refused. However, Dow’s good friend, S.A. Nelson, published 15 of Dow’s Wall Street Journal editorials in a little volume entitled, “The ABC of Stock Speculation.” A footnote at the bottom of each chapter refers to the editorial as “Dow’s Theory.” But Dow himself never once used the term.

Following Dow’s death, two other men took over editorship of the Journal for brief periods. They were followed by William P. Hamilton, who was the fourth editor of the WSJ. Hamilton wrote a brilliant series of 252 editorials. These pieces appeared in the Journal between 1903 and 1929, and in Barron’s (the Journal’s sister publication) during 1922 to 1929. As time passed, Hamilton’s writing attracted a wide and devoted following. In 1926 Hamilton wrote his landmark book entitled, “The Stock Market Barometer,” in which he presented his own version of Dow Theory.

Hamilton had been Dow’s understudy at the Journal, and in his book he included much of Dow’s market observations and philosophy. But Hamilton also presented his own views on Dow Theory, and it was Hamilton who first defined the confirmation principle of the Averages. Hamilton died in 1930 soon after writing his most famous editorial, “The Turn of the Tide” (written on October 25, 1929). This fateful forecast served as the obituary for the amazing and hugely speculative 1921-’29 bull market.

The next great writer in the Dow Theory chain was Robert Rhea. Rhea was a devoted student of Hamilton’s, and Rhea adhered closely to Hamilton’s version of Dow Theory. Over a period of many years, Rhea codified and refined Dow Theory, always deferring to Hamilton in his explanations. I’ve studied every work and sentence that Rhea ever wrote, and in my opinion, Rhea was the greatest market trader of his time.

Rhea possessed a marvelous, instinctive gift for reading the Averages. He had an uncanny ability to identify and trade on the secondary as well as the primary trend of the market. Rhea was bed-ridden with TB, and he relied on his remarkable trading ability to support himself and pay his costly medical bills.

On November 12, 1932, Rhea started a stock market service which he titled, “Dow Theory Comment.” The service was successful from the start. Rhea called the exact bottom of the bear market on July 8, 1932, a feat which I consider one of the most remarkable in the history of stock market analyses. Rhea’s early letters were written during the depths of the greatest depression in American history, and you can imagine the skepticism with which his almost shocking bullish reports were greeted. Rhea also called the turn (to the downside) in the bear market of 1937, and this feat, even more than his 1932 bull market call, made Rhea a household name on Wall Street.

Sadly, Rhea’s disease took its toll. Only seven years after he started his advisory service, Rhea died (1939). Following Rhea’s death, the Dow Theory lay dormant for the many years during WWII and afterwards.

The next major figure in Dow Theory was E. George Schaefer of Indianapolis. Schaefer started his career as a stock broker with Goodbody & Co. He spent many years studying the writing of the great Dow Theorists who preceded him. But Schaefer concentrated his studies on the brilliant and seminal writings of Charles Dow. Schaefer was a firm believer in VALUES. One of Schaefer’s favorite quotes from Dow was, “An investor who will study values and market conditions, and then exercise enough patience for six men will likely make money in stocks.”

Another Dow quote used by Schaefer states, “It is always safer to assume that values determine prices in the long run. Values have nothing to do with current fluctuations. A worthless stock can go up 5 points just as easily as the best, but as a result of continuous fluctuations the good stock will gradually work up to its investment value.”

Schaefer believed that both Hamilton and Rhea placed too much emphasis on the pattern of the Averages and not enough emphasis on the principle of buying great values and holding those values throughout the life of a bull market. Schaefer wrote, “It has always been of interest to me that Hamilton and Rhea . . . both steered away from Dow’s thinking in many respects. Hamilton was very reluctant to give Dow the full credit he deserved. And Rhea, in turn, disregarded the works of Dow almost entirely and specialized in trying to improve the Hamilton version of Dow Theory.”

In 1948 Schaefer started his own advisory service which he called, “Schaefer’s Dow Theory Trader.” Schaefer’s timing was fortunate but more probably brilliant. On June 13, 1949, with the Dow at a multi-year low of 161.60, one of history’s great bull markets began. Exactly five days from that low, on June 18, 1949, Schaefer wrote what I consider an advisory masterpiece (I still have that report). In that piece Schaefer stated his reasons for believing that a great buying area was at hand and that a major bull market had begun.

In that June 18, 1949 report Schaefer wrote, “The philosophy of Charles Dow always gave first consideration to values, then to economic conditions and third to the action of both the Industrial and Rail Averages. When the low point of a bear market is reached, values will be the first indication of a change in trend. In the past 17 years only three opportunities have presented themselves to buy stocks at great values. Now the fourth opportunity is making its appearance.”

Schaefer’s June ‘49 forecast turned out to be uncannily accurate. In June the Dow turned up from its 161.60 low, and a great bull market began. Schaefer stayed with the bull market through thick and thin until 1966. On February 9, 1966, 17 years later, the Dow topped out at a value of 995.15. Those who followed Schaefer’s Dow Theory interpretations and investment procedures (i.e., those who held their stocks throughout the bull market as Schaefer repeatedly advised) made fortunes.

One of the reasons Schaefer started his advisory service was to present what he terms his “New Dow Theory,” a set of principles which he insisted “could be applied profitably to present-day markets.” Schaefer wrote in 1960, “A study of the Averages themselves can be highly rewarding. But in my opinion, a forecast based on past movements of the Averages cannot be conclusive. Predictions of events to come are more reliable if they can be reinforced by analysis of other technical and more conclusive factors.”

What were the “other factors” which Schaefer referred to? Some of them were values (and again I emphasize values), the 200-day moving average of the Dow, the short interest ratio, the advances and declines, Dow’s 50% Principle, market sentiment, market phases, and the yield cycle. Remember, prior to Schaefer, orthodox Dow Theorists tended to avoid all “extraneous” items other than the pattern of the Averages and volume, claiming that other items only interfered with pure, basic, Dow Theory studies. Schaefer disagreed vehemently.

Schaefer possessed great market intuition, and he used his market instincts plus his new tools to ride the great 1949-’66 bull market all the way from the bottom in 1949 to the top in 1966. Through reactions, corrections, panics and dips, Schaefer insisted that his subscribers hold their shares and buy more during all periods of weakness.

That may sound easy, but believe me it is not. The number of people who hold stocks from the beginning to the end of a bull market can probably be counted in the hundreds. In early-1966, Schaefer turned bearish on the market (based on third phase considerations and overvaluation of stocks), and he advised his followers to “sell out.” Schaefer remained bearish until the time of his tragic and untimely death (suicide) in 1974.

Although Hamilton and Rhea took careful note of the secondary reactions in bull and bear markets, Schaefer advised his subscribers to ignore these “temporary reactions,” and to remain invested in harmony with the primary trend of the market. In his historic report of June 18, 1949, Schaefer wrote, “Once stocks are purchased, both the minor and secondary movements in the market should be completely disregarded. A new period of prosperity will follow, once the present recession has run its full course.” We now know how prophetic those words were (words which were written during a time of extreme fear and gloom) .

Later Schaefer wrote, “So far as I can ascertain from his original writings, Dow had an open mind, and there was a great deal of flexibility in his thinking regarding the price movements.”

The following is extremely important, and subscribers should take careful note of this: Schaefer believed that mass emotions were changing the character of the stock market. He realized that Wall Street was gathering a much larger following year after year, and that the American public was becoming much more involved with investments (today, of course, Wall Street has gone both electronic and global). This relatively new phenomenon of mass emotions, Schaefer believed, had to be taken into consideration as far as classic Dow Theory was concerned.

Wrote Schaefer, “My new Dow Theory involves a broad, balanced manner of thinking about the market and your own emotions. It is a far cry from the narrow ’system’ that places a complete reliance upon what the Averages do. Yes, we who study the new Dow Theory watch the Averages. But along with any such observations we realize and understand that the market is composed of people of all types, and that all people are born emotional.”

So what was the result of Schaefer’s emphasis on the emotions of an enormous and growing investment public? It was this — Schaefer allowed for secondary reactions to far overshoot the restrictions which were laid out by orthodox Dow Theory. Years earlier Rhea had written that in a bull market, secondary reactions tend to retrace one-third to two-thirds of the preceding uncorrected primary advance while tending to last three weeks to three months.

Schaefer dismissed Rhea’s “out-dated concepts.” Schaefer believed that mass psychology and the intense emotions of the public could take the Averages well beyond the “normal bounds” outlined by Hamilton and Rhea. Wrote Schaefer, “Today our new Dow Theory allows the crowd to get as emotional in its selling or buying as it will — with no restrictions whatever on the duration or extent of the secondary or intermediate trend. In primary bull markets, when things get scary, we simply wait for the fearful to sell out, and then we assume that the main primary trend will resume as expected. In primary bear markets, just the opposite is true.”

This “new Dow Theory” thinking proved extremely valuable in late-1957 when a severe secondary reaction hit Wall Street. When the Averages broke through their preceding secondary lows, many orthodox Dow Theorists, who relied almost totally (as most do today) on the pattern of the Averages, proclaimed that a bear market had started. These bears ignored such critical factors as the phases, length of the bull market, values, Dow yield, etc.

Schaefer differed totally (as I did in 1957) with the prevailing Wall Street opinion. Both of us insisted that the bull market had not yet experienced a classic speculative third phase and that the late-1957 cave-in was not a bear market but a severe secondary reaction. We held that the reaction had been intensified by extraordinary public fear, fear that was triggered by the violent breakdown in the Averages.

In fact, I was so certain during 1957-’58 that we were witnessing a bull market correction rather than a primary bear market that I started Dow Theory Letters at that time. Furthermore, in December 1958, I wrote my first article for Barron’s (entitled “Dow Theory Revisited”). That Barron’s article drew a tremendous response and was instrumental in putting me in business (in the years that followed I wrote about 30 additional articles for Barron’s).

Basic to both Schaefer’s and my thinking during 1957-’58 was the fact that we had not yet experienced a bull market third speculative phase. Also, during the drastic 1957 decline the 50% Principle remained bullish.

Let me explain because this is important. The Dow had risen from a 1953 low of 255.49 to a record high in 1956 of 521.05. The halfway or 50% level of that three-year rise was 388.27. On the vicious 1957 decline the Dow collapsed to a low of 419.79, a level which was well above the 388.27 or the 50% level of its preceding rise. The fact that on the decline the Dow could retain better than half the gains of the 1953-’56 rise was a powerful bull argument, particularly since this phenomenon occurred in the face of such universally black pessimism (by the way, I have never, before or since, seen gloom to match that which existed during the 1957-’58 recession and market collapse).

Back to George Schaefer. Schaefer used the 200-day moving average of the Dow to advantage in his work. But he warned “that as with other technical studies, the 200-day moving average should never be considered alone. My experience has been that interpretations under the 200-day moving average rule must always be correlated with other studies.”

The experience during the 1949-’66 bull market served me well. The 200-day MA turned down in 1953 (during a secondary correction), and it turned down again in 1956 (during another secondary). Neither of these downturns in the MA indicated that the primary trend of the market had turned bearish, and each of the downturns in the MA was followed by a major rise as the bull market reasserted itself. Thus, those who say that the direction of the 200-day MA identifies the direction of the primary trend would do well to study history. But Schaefer noted, “the 200-day MA should never be used alone and to do so can cause expensive mistakes.”

I wrote the foregoing because I wanted to give subscribers an accurate (even though brief) view of Dow Theory and its evolution over the past 90 years. Few, very few, market practitioners have ever made a serious study of Dow’s Theory, although many analysts mouth meaningless Dow Theory platitudes. I know of only a handful of people who have ever read the works of Dow, Rhea, Hamilton or Schaefer. Yet, the Dow Theory remains the basis of all technical analysis. The Theory also constitutes the basis for much intelligent and profitable investing. I have shown how the Theory has evolved through the years. I have also attempted to show how the Theory has been improved with each Dow Theorist and how each practitioner has worked with the Theory and applied it to the particular markets of his time.

I’ve tried to carry on the work of Dow, Hamilton, Rhea and Schaefer. I believe, however, that the stock market is far more difficult today than ever before, mainly because so many analysts, professionals, money managers, arbitrageurs, speculators and serious individuals are involved, and competing for profits (and increasingly, for short term and even intra-day profits). Furthermore, trading has been speeded up and broadened tremendously through the use of computers and the Internet. Finally, the arrival on the scene of “derivatives,” options, futures, puts, calls, etc., makes the market game bigger, faster, more manipulative, more hazardous — and far more deceptive than ever before.

In the end, however, the “hidden ingredient” for market success is the practitioner’s own instincts or intuition. Market analysis, as some many have observed, is an art, not a science.

I guess every Dow Theorist (and every market practitioner) has added or latched on to a few devices which he feels will help him with his market studies. I’ve developed my Primary Trend Index. This composite Index has been a huge help to me in my own trading. As a matter of fact, many of my own subscribers base their market position strictly on the trend of the PTI.