Category Archives: Dow Theory

Reader BlueIce comments (found here):

“So for the past four years, the NYSE is up but volume down…What is the root cause, if any? Bank Bernankski ?”

Our Response:

While there is considerable belief that the Federal Reserve has been the main driver in the financial markets since the March 2009 low, we believe that the Fed’s activity has NOT YET been felt in the stock market.  First we’ll explain the two primary reasons we believe this. Afterwards, we’ll explain what we believe are the possible outcomes to the Fed’s current policies.

First, in our January 19, 2011 article titled “Federal Reserve Isn’t to Blame for the Current Market Run” (found here), we concluded with the following thought:

“A cursory review of market data during the periods from 1860 to 1914 makes it clear that declines of nearly -50% or more are likely to retrace +66% to +100% of prior declines. This pattern has been easily demonstrated in the periods after 1914. However, we’re only trying to illustrate that the acceptance of the Federal Reserve’s role as the leading cause of the current +69% retracement of the prior decline (2007-2009) is false.”

We’ve maintained the view that the Federal Reserve’s impact on the stock market has been muted so far. 

Second, regarding the issue of manipulation of the markets, which is implicit in the discussion of the Federal Reserve’s involvement in the rise of the stock market, we take the Dow Theory view on the topic. Charles H. Dow was very specific about market manipulators and manipulation. Dow has said that manipulation is a factor of the market in the day-to-day movement. However, the long-term trend of the market cannot be manipulated as demonstrated in detail from the writings of William Peter Hamilton, former editor of the Wall Street Journal.

Hamilton says of manipulation:

“The market is always under more or less manipulation.”

“Even with manipulation, embracing not one but several leading stocks, the market is saying the same thing, and is bigger than the manipulation”

“Major Movements Are Unmanipulated-One of the greatest of misconceptions, that which has militated most against the usefulness of the stock market barometer, is the belief that manipulation can falsify stock market movements otherwise authoritative and instructive”

“These discussions [of manipulation] have been made in vain if they have failed to show that all the primary bull markets and every primary bear market have been vindicated, in the course of their development and before their close, by the facts of general business, however much over speculation or over-liquidation may have tended to excess, as they always do, in the last stage of the primary swing”

“It has been shown that, for all practical purposes, manipulation has, and can have, no real effect in the main or primary movement of the stock market, as reflected in the averages. In a primary bull or bear market the actuating forces are above and beyond manipulation. But in the other movements of Dow’s theory, a secondary reaction in a bull market or the corresponding secondary rally in a bear market, or in the third movement (the daily fluctuation) which goes on all the time, there is room for manipulation, but only in individual stocks, or in small groups, with a well-recognized leading issue”

(Source: Hamilton, William Peter, The Stock Market Barometer, Wiley & Sons, New York, 1922.)

The Fed and world central bank manipulation has an impact on the day-to-day and maybe the medium-term, however, the long term will exert itself regardless of the manipulation.

Finally, while we are skeptical about the Dow Theory secular bull market indication, we have to accept that it is real. As with most economic policy, the impact is felt long after the implementation. Dow Theory might be saying that we’re about to enter a phase hyper-activity in the stock market. If this is the case, then we just might see the impact of the Federal Reserve’s stimulus of the last several years finally kick in, catapulting the stock market to unbelievable heights.

The lack of trading volume in the stock market since 2009 reflects little or no participation on the part of the public.  If this is true, then any meaningful rise in trading volume (on the buying side) due  to added participation from the public could result in tremendous gains.  This thought sits in the back of our mind as we strategize the best way to take advantage while not being over exposed.

When we say that the public hasn’t participated in the stock market’s rise, who cares?  The answer is the very financial institutions that required bailouts in 2008.  They have been trading amongst each other in a game of hot potato.  If the public doesn’t jump in soon there could be major fireworks to the downside.

Again, if the Dow Theory bull market indication isn’t real then we’ll see another round of “too big to fail” institutions coming with hat in hand to the U.S. government.  The most vulnerable institutions could be those that were forced to merge with companies like Bank of America/Merrill, Wells Fargo/Wachovia and JPMorgan/Bear Stearns.  From our research on this topic, we’ve seen what happens when a sizable failed institution is forcibly merged with an ailing but salvageable company (i.e. our article on CreditAnstalt).