The Dow Report: Lessons From The Past
By Tim W Wood CPA, November 21, 2003
As a market historian, it is my belief that if we study the markets of the past, we can gain valuable insight into the future. If you think about it, how can you discern a given market situation if you have never been exposed to it before? So, it’s logical to me that we can gain our experience in one of two ways. We can learn from the school of hard knocks and let unfamiliar situations teach us the hard way or we can learn from history. Now, I also realize that simply studying the past is not exactly the same as first hand experience. However, I would much rather be armed with the lessons of the past than not. Also, if you think about it, our formal education is really nothing more that the study of history. Our professors taught us to be the engineer, doctor, accountant, lawyer, or whatever, largely through the study of history. The engineer learns design structure through the experience of his predecessors. The doctor is taught based on analytical and diagnostic principles that were learned and developed by his predecessors as well. The lawyer studies case law and so forth. If you think about it, a large part of any profession is learned through the study of history. Yet, it seems that most participants in the market make very little if any study of the past.
William Peter Hamilton, 1922 wrote, "The small speculator, and more particularly the small gambler, suffers at the hands of the professional. He is a follower of "tips" and "hunches." He has made no real study of the things in which he trades. He takes his information without discrimination at second hand, lacking the ability to distinguish good from bad."
Robert Rhea, 1932 wrote, "It is doubtful whether any trader has ever operated successfully over a long period of years unless he has devoted much time and study to the work."
My basic point here is that most people operating in the market today have never seen a bear market. Given the duration of the preceding bull market this is understandable. As a result, all they know is what they have learned from the bull market of the last two decades. Worst yet, they have never truly studied market history. They are conditioned to think that they must buy the dips and that they can’tmiss a rally because it is likely to be the beginning of a new bull market. This is like a lawyer trying to defend someone, yet he has never made a real study of case law. The lawyer in this example would have no basis or grounding in which he could build his case. It is my opinion that the vast majority of the talking heads are completely ignorant of long-term market history. All they know is what real life experience has taught them over the last couple of decades. Now that times have change, they can’tsee it because they have no historical grounding or experience to draw from.
On October 23, 1929 William Peter Hamilton saw that the bear market had been signaled. The next business day, Hamilton wrote his famous editorial about that signal in the Wall Street Journal entitled A Turn In The Tide. On May 27, 1933 Robert Rhea wrote that the new bull market had been confirmed. These guys were able to make these calls because they knew market history and as a result they knew what the turning point looked like.
Now, I'm not saying that just because I'm a market historian that I have all the answers. What I am saying is that history is our best teacher and in believing that, I have not limited my study of the averages to recent history. I have analyzed the markets from 1896 to present and as a result I feel fairly confident in saying that we are still in the first primary phase of a monster bear market that is not likely to end until 2006 or possibly 2010. The only questions are when will this rally be over and how can investors best position themselves in light of this primary bear market?
One consistency that I have found in my study of the great Dow theorist's of the past is that they primarily operated in the direction of the primary trend. I could not agree more. Trying to buy a bear market rally is no different than trying to short the declines in a bull market. There is no way to know how far these counter trend rallies will carry. It's really like swimming against the tide and thus much more speculative. Why swim against the tide when we can swim with it? The great Dow theorist in the past would stand aside for months while patiently waiting for the market to setup. For those who may be beating themselves up a little over the rally, I want to offer you the following works from the book Making The Dow Theory Work 1939, by Sparta Fritz and A.M. Shumate.
"The most elusive move in the market cycle, aside from the minor moves, which we are disregarding, is the secondary rally in a bear market. It is usually expected more than once before it actually occurs, and runs its course abruptly, to finish just about the time that the chronic bulls begin to take heart. It would be labeled the most dangerous chance in the market cycle."
From Robert Rhea's book, The Dow Theory, 1932: "Bear markets seem to be divided into three phases: The first being the abandonment of hopes upon which the final uprush of the preceding bull market was predicted; the second, the reflection of decreased earning power and reduction of dividends, and the third representing distress liquidation of securities which must be sold to meet living expenses. Each of these phases seems to be divided by a secondary reaction which is often erroneously assumed to be the beginning of a bull market. Such secondary movements seldom prove perplexing to those who understand the Dow theory."
Rhea's explanation of these phases is somewhat abbreviated. However, I can tell you that based on my study of market history, it is my opinion, that the rally seen since the March 2003 low will likely prove to be the rally that separates the first bear market phase from the second one. It is through my newsletter, Cycles News & Views, that I present market history, Dow theory, cyclical concepts and much more all in an effort to help investors understand the current market climate as well as how and when to best take advantage of it.
Chart courtesy: www.stockcharts.com
Tim W. Wood
© 2003 Tim Wood