November 16, 2007 12:49 p.m. EST TAKING STOCK Dow Theory Close To Confirming Bear Market By SPENCER JAKAB A Dow Jones Newswires Column NEW YORK -- To devotees of the oldest and most famous technical indicator, an impending bear market may be confirmed by one more leg down on the Dow Jones Industrials -- 264.27 points to be precise. Leading proponents of Dow Theory point to the August closing low of 12845.78, just over 2% away from Thursday's final figure, as the red line that must be crossed fairly soon to confirm that stocks will have a nasty drop ahead of them. "We'd be in a primary bear market," said Richard Russell, editor of Dow Theory Letters. One of two necessary criteria has been met to set up the conditions Dow Theorists are eyeing. The Dow Jones Transportation Index already broke through its support level of 4672.35, and Friday's bad news from FedEx Corp. (FDX) pushed that average deeper into the danger zone. Russell says it doesn't matter how much lower the Transports go, as the Industrials are now the key. Conversely, a stubborn failure to break through their low would be a bullish signal. Given some of the nasty days lately -- there have been eight drops of at least 267 points this year alone -- the bear market signal could come in a single day's trading. Dow Theory is based on the letters of Charles Dow, one of the founders of Dow Jones & Co. (DJ), which publishes this newswire. The first editor of The Wall Street Journal, he never gave his own name to the criteria he used, but disciples did so when they formalized some of the rules after his death in 1902. One obvious question that comes to mind is how relevant a drop in transports is today given that the criteria were developed before Orville and Wilbur Wright had flown the first airplane or most people had ever laid eyes on an automobile. Of the 20 components in the Dow Transports today, only four -- Union Pacific Corp. (UNP), CSX Inc. (CSX), Norfolk Southern Corp. (NSC) and Burlington Northern Santa Fe Corp. (BNI) -- are railroads, which dominated the index at the time. FedEx, which warned Friday, has a larger index weighting than any of them. To Dow theorists though, the mode of transport is irrelevant since the industry is such a barometer of the economy. "They show whether goods are moving or not," explained Russell. One reason for continuing interest in Dow Theory is that it has been associated with some major market calls, both for bear and bull markets, though there were some miscues that get less emphasis. One of the original Dow theorists, Journal editor William Hamilton, issued a call for a bear market just days before the 1929 stock market crash, though he had also done so nearly four years earlier, causing his followers to miss part of one of the great bull markets of all time. Another original Dow theorist, Robert Rhea, famously called a market bottom in July 1932, just two weeks after the bear market low that had seen stocks lose almost 90% of their value. The Dow rallied by nearly 380% from trough to their next peak in 1937, around the time when the signals told Rhea to exit the market. Another famous set of calls came from Richard Russell himself, who pinpointed the top of the market in 1966, just two days after the peak and ahead of a nasty decline. Even more famously, he called a market bottom in late 1974 after stocks had dropped by nearly half and pessimism about stocks was at multi-decade highs. In the absence of a clear Dow Theory signal, he also called for a bear market in August 1987, which was when stocks actually peaked before the October 1987 crash, the worst one-day drop in history. Skeptics about Dow Theory or technical analysis in general can point to academic studies showing that it barely outperformed a buy-and-hold strategy, though others give it higher marks on a risk-adjusted basis. Despite some bad calls though, the uncanny history of identifying major inflection points should at least give investors pause considering all the other storm clouds on the horizon. According to Russell, if the Dow Industrials breach their summer low then the sell-off could be ugly. "Once you get a bear signal, there's no telling how far it will go," he said. (Spencer Jakab previously wrote the STREET SAVVY column, which has been rebranded as TAKING STOCK, a new global column which gives insightful analysis about equity-related topics around the world.) ---By Spencer Jakab, Dow Jones Newswires; 201-938-2429; spencer.jakab@dowjones.com (TALK BACK: We invite readers to send us comments and share their views on financial news topics. Please email us at TalkBackAmericas@dowjones.com. Readers should include their full names, work or home addresses and telephone numbers for verification purposes. We reserve the right to edit and publish your comments along with your name; we reserve the right not to publish reader comments.)
Thanks for posting. I am just starting to study Dow theory. The more I learn and trade the more I realize the pioneers like Wyckoff, Dow, Livermore is as good as it gets.