June 20th, 2012

Resuscitating The Near Dormant Dow Theory

An old name made the news this week with his dire prediction: Richard Russell.  You may never heard of Russell but he’s been around ever since the very first days that I became interested in stocks many years before most of you were born.  Russell began publishing a newsletter called the Dow Theory Letters in 1958.  He’s written Dow Theory Letters for well over 50 years, with six updates per week for much of that period.

However, his current opinion has recently surfaced in the general business press for some inexplicable reason.  The headline that’s making the buzz is “Don’t Believe This Rally & Prepare Yourself”  Do a search on this headline and you’ll see all the blogs that referenced it.  For those who haven’t seen it elsewhere, Russell’s points are:

“The best way to describe the primary trend is to compare it with the great tide of the ocean. Once the tide turns down (as now) I compare it to a broad irresistible force. It’s a force that can’t be timed or described in detail.

 

It’s an invisible force, but it exerts a pull that has an effect on almost all stocks. The weaker stocks are swept along rapidly by the primary trend, while the stronger stocks are pulled along more slowly.

 

The important consideration is that most portfolios of stocks will be under water by year’s end. You can be sure that the bear market will try to make you believe that you should be in this market. One way or another, the bear market will have you doubting that it’s really a bear market.

 

“How far will the bear market carry? No one knows. Already all of 2012’s gains have been wiped out. There’s a number down there to where the bear market is heading. I don’t know what that number is. Dow 8,000? Dow 6,000? Dow 4,000? Dow 2,500?”

 

“The number could be any one of these. What I hope is that we get to that number as quickly as possible. I just hope we get the pain of the bear market over as fast as possible. One mistake is to think we know how costly the bear market is fated to be — and how far the bear market will carry. The Primary trend is a law unto itself. It will continue until it dies of exhaustion.

 

In the meantime, the bear market goes on. I’m afraid it has a long way to go.

 

Russell’s claim of an imminent bear market of huge dimensions stems from what he sees as an apparent divergence between the two Dow Indexes.  I looked and the only divergence I could find that might point to a bear market on the order of Russell’s prediction is the fact that the 2012 peak in the Transportation Index wasn’t higher than the 2011 peak; for the Industrials the 2012 peak was higher:

The Dow Theory evolved in the 1930’s when the country had a very different economy.  Most people worked in manufacturing.  Most goods were transported on rails rather than by trucks on the country’s highway system.  The economy was essentially domestic as contrasted with today’s outsourced and imported global economy.  One of the critical elements of the Dow Theory is that the 20 stocks of the Dow Transportation Index should move in synch with the 30 stocks of the Dow Industrials.  If the Industrials move to a new high then so should the 20 Transportations.

My own Market Momentum Meter is currently flashing Bull/Green and the market is close to a perfect bullish alignment where the 50-dma is above the 100-dma which is above the 200-dma which, in turn, is above the 300-dma and all are trending higher; the Index itself is above them all.  If the market is able to cross above 1365 and stay at that level or higher for a week or two then a certified bull market is indicated.  [Coincidentally,  that should coincide with when the “sell in May” phase ended in each of the prior two years.]

So there’s only one reason I can imagine for Russell to drag out such a “newsworthy” prediction.  It can only be to garner free publicity to shack out some new subscribers who are predisposed themselves are uncertain and fearful.  From a contrarian perspective, that’s precisely the sort of environment out of which emerges a bull market.