Dow Theory
Confirms
Bear Market
The
latest debate has the great baby boomer, liquidity driven bull market of
the 1990's ended? Mitch Harris' work strongly suggests that it has, in the
classic fashion that he has been observing in recent issues of Reality
Check, an investment newsletter.The
Dow Theory was originated by Charles
Dow in the late 19th Century during his days as the editor of the Wall
Street Journal. Originally devised as a general barometer for business
and economic activity, it was refined over the next 27 years by his successor,
William Hamilton, into the indicator that we know and use today.The
theory separates all stocks into three categories, industrials, transports,
and utilities. The latter is not taken into account in classic Dow Theory.
The concept behind the theory is that when business is healthy, raw goods
must first be transported to factories in order to be manufactured into
finished goods. These goods must then be transported to the market in order
to satisfy customer demand. During this period, the share prices of both
transportation and industrial companies generally rise together to reflect
the healthy condition confirming that the trend is bullish.When
demand begins to slow, the theory suggests that it will be reflected in
prices as the two averages stop moving together. As a leading indicator
it warns that something is changing as the continued trend is no longer
being confirmed. Non-confirmation occurs as one index continues to
rise (or fall) while the other doesn't. As the transition develops, the
transports usually stop rising first as few raw goods and finished products
are shipped, reflecting growing inventories as production rates were sustained,
but demand began to diminish. The industrials continue advancing until slowing
demand becomes more evident.I
believe this to be the result of management's over enthusiasm beyond the
point that demand remains strong. It is a natural human tendency to seek
to rationalize away reality in exchange for more hoped for rewards, a sort
of Pavlovian denial that things do change for the worse (that good things
can't and indeed don't last forever).The
Dow Theory is the very most basic and original form of technical analysis
because it simply defines when the general trend of the market is up or
down. Recently, we've pointed out that the two averages had stopped making
new highs together, calling the bull market into question. The severe decline
of the world markets in the past month brought with it new lows in both,
the Dow Industrial and Transportation Averages.By
definition, a bull market is in force when prices progressively make higher
highs and higher lows. A bear market is in force when prices progressively
make lower lows and lower highs. The latter became the case with the Dow
industrials plunging 300 points on August 4th. This broke below the bottom
of the June correction and confirmed the lower lows already being made by
the transports, turning the general trend of the market down. The bearish
trend will not remain in force until both averages re-establish new
highs together again. This was the first major Dow Theory signal since turning
bullish in January, 1991.Investors
Intelligence reported that since
the sell signal was confirmed, surprisingly, only two of the 140 advisory
newsletters they follow even made mention of it. We view this as very worrisome
because it implies that the supposedly most impartial professionals either
don't fully understand their business, don't use all the time-tested tools
at their disposal, or remain in denial that the good times could be changing.What
to expect going forward? The key here is that no matter how many warnings
of the incredible and serious risks given to investors, the vast majority
continue to ignore them, remaining conditioned to buy the dips. We define
the 10% decline from the 7/20 high as an initial downside thrust.
Just like the initial surge at the beginning of a bull market that takes
prices much higher than trading oscillators can define, this brought prices
down in equal fashion. Of course, the majority just see it as another buying
opportunity on the way to their promised land of vast riches. This will
likely be reinforced further in the next few weeks as greed once again drive
prices a bit higher before the next bout of selling on fear re-emerges.
Unfortunately, if the Dow Theory withstands another test of time, this time
it really will be different, for the vast majority who have been successfully
conditioned to ignore its message!"Source: Mitch
Harris, editor, Reality Check, 923 Monastery St., Cincinnati, OH 45202,
1 year, 12 issues, $200.