Anyone for Dow 2500? Dow theorist Richard Russell raises the prospect in Barron's. I'm not dismissing the theory, but Russell would have had you out of stocks in 1997...
The ogre of deflation
Mark Hulbert, Forbes Magazine, 11.17.97
THERES A BETTER than 50-50 chance that a major bear market has begun. Thats what Richard Russell, editor of Dow Theory Letters, told me in the wake of the markets late-October plunge. His advice: Get out of stocks now.
Heres why we should listen to Russell: He is the granddaddy of the investment letter industry, having written his letter since 1958 -- longer than any other market letter currently publishing. His is one of only three letters among those tracked by the Hulbert Financial Digest whose market-timing advice has beaten a buy-and-hold over the last decade on a risk-adjusted basis. He hasnt always been right by any means, but he has an impressive record calling the markets major turning points.
He correctly anticipated the 1987 crash, turning bearish in late August of that year -- within days of that summers high. He turned bullish in January 1975, only a few weeks following the bottom of the terrible 1973-74 bear market. And he turned bearish in 1966, after the DJI first broke the 1000 barrier; it took the market 17 years to get decisively through that barrier again.
Despite the name of his letter, however, Russell doesnt base his current bearishness on the Dow Theory as its commonly practiced today.
Its too early for that. According to the modern interpretation, were still on a buy signal. For it to generate a sell signal, two conditions must be met: The markets post-crash rally must fail to take the Dow industrials and transports to new highs, and, in the wake of that failure, both averages must drop back below their late-October lows.
That could take weeks, and Russell isnt waiting. He believes the market will be relentless on the downside and will not accommodate investors who want to get out but who are waiting for a significant rally back toward the August high. Russells unhedged advice: Dont wait for a rally. Get out now.
Russell contends that hes actually being more faithful to the original Dow Theory than are those who have reduced it to a formulaic, trend-following system. The theory was codified by William Peter Hamilton in a series of Wall Street Journal editorials between 1902 and 1929. And, according to Russell, Hamilton focused above all on market valuation. He is certain that if Hamilton were alive today he already would have been out of stocks, prior to the late October plunge, on the ground that they were overvalued.
Russell reminds us that the Dow Theory places great importance on divergences between the actions of the Dow industrials and the Dow transports -- referred to as nonconfirmations. Note that in September and October, while the DJT was rising to new highs above its previous early- August high, the DJI never surpassed its Aug. 6 high. This was a flagrant nonconfirmation.
To be sure, the monetary environment appears to be positive. The U.S. bond market has been rallying strongly; this takes some pressure off the stock markets overvaluation.
But Russell isnt buying this line of reasoning. Far from celebrating the absence of inflation, Russell believes, the stock market should be worried about deflation. While deflation is unambiguously good for the bond market and might be short-term bullish for equities as well, eventually its going to be bearish for stocks. Thats hard for people under 70 to understand, because they have never experienced deflation.
Russell says the strongest deflationary signal comes from the precious metals market. Gold, the original inflation hedge, recently dropped to its lowest level in 12 years. Another deflation signal comes from the Feds willingness to allow the money supply to surge, which Russell believes indicates that the Fed is acting to counteract global deflationary pressures.
How far could this bear market go? Russell offers no prediction, reminding us that the Dow Theory does not forecast the extent or duration of any market move. But he is willing to speculate: He suspects that before this bear market is over, the stock market will have broken just as many valuation records at the bearish end of the spectrum as it has broken at the bullish end over the past few years. And thats a scary prospect.
forbes.com |
