Dow Theory calls a bull market

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The long-awaited Dow Theory bull market signal finally arrived yesterday. This came about as a result of the Dow Jones Industrial Average and the Dow Jones Transportation Average both breaking through their previous rally peaks (registered on 12 and 11 June respectively).

The charts are shown below.

23-july-09-1

Source: StockCharts.com

23-july-09-2

Source: StockCharts.com

Although the breakouts provide confirmation of the nascent uptrends, one may question the relevance of the Averages as representative benchmarks in the modern economy. Also, most indices are quite overbought after very sharp moves over the last 12 days.

In my opinion, it could be dangerous to blindly put one’s faith only in Dow Theory and investors should at all times rather base their decisions on a combination of fundamental and technical indicators.

While Dow Theorists delight in the bull signal, it is appropriate not to lose sight of the economic picture, as aptly summarized by David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates: “Well, the S&P 500 surged 15% in the second quarter and what we did was go back in the history books to see what happens to the economy the very next quarter typically after such a big bounce and the answer is … just over 3% real GDP growth. So consider that de facto what is being discounted at this time for current quarter growth – it better be a humdinger of an inventory build.

“Now, for the market to build on such a rapid advance in the current quarter, history again suggests that we would need to see 5.5% real GDP growth, which we give near-zero odds of occurring. Hence our call for a sputtering stock market through year end. Too much growth – and hope – are priced in at this point.”

Richard Russell, “Mr Dow Theory” and author of the Dow Theory Letters, yesterday replaced the bear on the first page of his daily newsletter with a long-horned Texas bull. “We follow the Averages blindly (via Dow Theory) the way a blind man follows his seeing-eye dog,” the long-timer added tersely.

We live in interesting times indeed!

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15 comments to Dow Theory calls a bull market

  • mike maslen

    what a load of BUlls.

  • GilbertB

    I used to truly believe Richard Russell… until now. Btw, belated happy birthday to him.

  • Gilbert: I should’ve mentioned that it was Richard’s 85th on July 22. Irrespective of what market may do, we wish him a long and healthy life.

  • Eric

    Russell has been whipsawed badly the last couple years…but I hope I am as active at his age. He’s a battler. Happy 85 RR!

  • [...] A Dow Theory buy signal.  (Investment Postcards) [...]

  • andre

    all nonsense, market running on hope, and nobody knows if economy will pick up in 2010. where is my crystal ball?

  • andre

    great !! our executives have shown that they can fire and cut costs. more left to speculate and blow on derivatives and bonuses ( for lucky traders). when we will get back to actually providing goods and services that we actually want ?

  • I wrote about the imminent Dow Theory confirmation by the Transportation Index on June 24 when I wrote: “there seem to be some interesting charts setting up in the various transportation Industry Groups that may point to a confirmation coming….Be prepared to hear a lot more over the summer about Dow Theory and the confirmation of the Industrials by the Transportation Index.” And here you are.

  • Frank W

    I think Russell got it right, when he said that this is just a rally in a bear market. Just because a rally is big, it doesn’t mean it’s a bull market. If memory serves me correctly, one of the rallies in the Great Depression measured 70%. Russell also probably had it right when he said that over his decades of working in the stock market he learned to stay out of these bear market rallies, because there is no way to predict what is going to happen. One cannot predict how far the market is going to rally, when it is going to peak out and how fast it is going to come back down. You can’t rely on measures of overbought or oversold. Just consider the present bear market. What is happening here makes no sense whatsoever. We have an earnings cycle in which losses are predicted to equal 35.7%, yielding a 98% decline since the 2007 peak. But the companies surprize on the upside by reporting a decline of only 35.2%. The market goes ballistic in ecstacy over this brilliant turnaround. I wait in eager anticipation of what it will do, if losses improve further to say 34.9%. I expect the market should clear the solar system. This is what Russell means when he says that he has learned to stay out of these rallies, because they make no sense whatsoever. Consequently, one has no idea, when to get in or get out. The previous 3 or 4 rallies to this one were so tepid that except for one of them that by the time you got set they would have been over. This despite the fact that the market was grossly oversold. The other, I think, approached 20%, which is hardly useful, considering the risk. What this is about, ladies and gentlemen, is lowest common denominator. A significant portion of the profession is convinced that the market is controlled by nitwits, know nothings and do anythings. They advise you not to do any sensible investing, because you will only lose, but rather think of what a halfwit would do, and do that. Since the large majority of investors have been sitting on their hands on the sidelines, the market is completely controlled by these idiots. Good on you, mate, if you can think like an imbecile and have jumped into a market that makes no sense whatsoever, because you have been rewarded with a big big wad of money. I confess I can’t do it. Consequently, I’m sitting on the sidelines collecting 0.1% interest in my money market account.

  • I would not put my faith in the Dow Jones Index. It only has 30 stocks. Put your faith in the S&P 500 Index with 500 stocks.

    What is happening in the market is unbelievable and I don’t believe it. I think mutual fund managers are driving the prices up to make a profit. When the market goes below its 20 moving average then you better jump off this run a way train.

  • Gumnaam

    @Frank W
    You must be really confused; can’t make up your mind. Better get out of this game because you will never be sure of anything. You will never be sure if you are seeing a bull or a bear. Why get stressed out for nothing?

  • [...] Sharp words about the failure of the media including the NYTimes with Walter Cronkite as foil.Dow Theory calls a bull market – Prieur du Plessis [...]

  • What is amazing about the Dow is that it was created out of thin air before any sophisticated computer generated math formulas were even a twinkle in Dow’s eye. The main reason not to put too much faith in the Dow Transportation Index these days are the now trendy short term inventory controls. Buyers buy only when needed and only buy exactly what their computers tell them to buy.

  • erik

    Dow Theory Signal?, So, Where is the volume?

  • Eric: The lack of volume is also what is worrying Richard Russell.

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