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Richard Russell Review: Letter 713

Posted on October 26, 2011 by | 2 comments
This review of Richard Russell’s Dow Theory Letters is dated November 9, 1977 when the Dow Jones Industrial Average was at 818.43 and the Dow Jones Transportation average was at 206.56.
  
Dow Theory
The first topic addressed by Richard Russell is Dow Theory.  On this topic, Russell says the following:
“THE PICTURE: As far as I’m concerned, as far as my studies of the Dow Theory are concerned, a valid primary bear market signal was given when, on October 24 [1977], the Transportation Average confirmed the prior bearish indications of the Industrials. There are always those who cry, ‘The signal was late, it was too late!’ But no competent Dow Theorist in history ever waited for an actual bull or bear signal before taking action! For instance, we bought stocks in December, 1974 before the 1975 bull market signal, and we sold our stocks in March and April of this year well ahead of the October, 1977 bear market signal. We bought and sold on many clear indications, and the final Dow Theory signal merely confirmed what we had suspected and had acted upon.”
First, we’d like to address when a bear market signal is most likely to have occurred after the bull market signal that was confirmed in January 1975. From our perspective, the bear market was signaled on October 5, 1976 for the Transports and October 8, 1976 for the Industials when both indexes fell below the late August 1976 lows.
For whatever reason, Russell acknowledges that the call was late but doesn’t confirm how late he was.  Looking back at the October 16, 1976 issue of Dow Theory Letters  (Letter 678), in the first issue after we believe the bear market began, Russell makes no reference to the dual violation to the downside by both indexes.  Russell does allude to the Transportation Average level of 200.88 which he believed the market to be “weak” if the index fell below such a point.  On October 16, 1976, Russell said the following:
“On the other hand, if the 200.88 level is broken, I would take this as a sign of unusual weakness, and I would take an even more cautious stance towards the market (which means selling more stocks and upping the bond portion of your portfolio even further.”
Naturally, there is a high level of inconsistency in suggesting that he would lighten up on his stock holdings if the Transportation Average fell below 200.88.  In the November 9, 1977 issue, Russell claimed that at the time the Transports fell below the indicated level he “sold our stocks in March and April of this year well ahead of the October, 1977 bear market signal.”
Although done in hindsight, our interpretation, almost a full year ahead of Russell’s call of a bear market, would have sheltered the investor from 3 times the loss.  This is consistent with our Dow Theory bull market indication in July 2009 and our more recent bear market call on August 2, 2011 (all NLO Dow Theory Bull Market articles) contrasted with Russell’s many bull and bear misinterpretations from March 9, 2011 (as partially outlined here).
The difference in Dow Theory Bear Market interpretations to the March 6, 1978 low:
Date
Transports decline
Industrials decline
Russell:
10/24/1977
-1.20%
-7.43%
NLO:
10/8/1976
-4.89%
-22%
Ironically, Russell says the following of those skeptical of the Dow Theory bear signal on October 24, 1977:
“…others said that if it was indeed a bear signal, then probably the greatest portion of the market slide was over anyway. Two days after the bear signal, the market rallied sharply, as if in disbelief.”
Since Russell’s call of a bear market was in fact long after the majority of losses were incurred, he only furthered the skepticism and misinformation of a useful tool for investors and businesses alike.  From the March 6, 1978 low to the April 27, 1981 high, the Dow Industrials increased by 37.87% while the Transportation Average increased 119.71%.  Alternatively, the Dow Industrials increased 23.17% and the Transports increased 117.55% after Russell’s indication that a bear market began on October 24, 1977.
Steps to a Dow Theory Bear Market signal:
  • July 14, 1976 Transports hit new high 231.27 but unconfirmed by Industrials
  • Sept. 21, 1976 Industrials hit new high at 1014.79 but unconfirmed by Transports
  • Oct. 8, 1976 both indexes fall below the late August lows-Bear Market begins
On page 3 of the DTL, Russell starts a Q&A with a question that has a very interesting answer:
“Question: Suppose we get a rally that turns out to be a huge advance? Then what, Russell?
“Answer: We have a number of ‘fail-safes’ that work on either the bull side or the bear side of the market. The one I’m thinking about in particular is my study of the three moving averages of the Dow. At this juncture, the 13-week MA is a whopping 71 points below the 50-week MA, and we would need a crossing to get a major bull signal. Furthermore, the 4-week MA (short-term MA) is at 814, 29 points below the 13-week MA (intermediate-term) which is at 843. We need a crossing of the 4-week MA above the 13-week MA merely to get a ‘buy-alert.’ That would take time. So in the absence of a full over-sold bottom, I would say, ‘Skip any rally that may be forthcoming, or wait for the Dow’s moving averages to cross.’”
There is a concern that we have regarding this section of Russell’s letter.  First, a “fail-safe” provision should address what actions to take if investments don’t work out.  Being out of stocks altogether isn’t investing nor is it working towards compounding, an overarching, albeit conflicting, theme in Russell’s work.  Therefore, Russell’s “fail-safe” observations based on a moving average requires reacting to a lagging indicator which compounds the delay in taking advantage of investment opportunities.  In fact, using such an approach causes investment activity, or lack thereof, to be made at the worst possible time.
In general, the use of moving averages for buy indications seems to be in contradiction to Dow Theory.  As pointed out earlier, moving averages are lagging indicators whereas the use of Dow Theory is supposed to act as a leading indicator.  Although Dow Theory provides bull or bear market indications not buy and sell recommendations, it can be effectively used to navigate market gyrations.  Based on the performance of the markets after Russell’s call of a bear market, it is clear that the mixing of moving averages and Dow Theory led to conflicting ideas of market direction that allowed Russell’s “Great” Depression bias to become the default reaction.
Treasuries
On page 4, Russell gives a quick blurb that had been overlooked for a long time in the mainstream media until recently.  Russell says the following:
“I might also mention that if the public became wary of the banking system, there could be a major move out of bank deposits and into Treasury bills.”
This has been the story of our experience in the market since 2008.  Furthermore, as the European Union struggles with their less than integrated banking system, demand for Treasuries grows.  This is in stark contrast to the belief that gold is king when there is a banking crisis.  We believe such a view is a holdover from when countries propped the price of gold with a gold standard.  The decline of gold and gold stocks in 2008 shows that there is another horse in the race for financial “safety.”
Gold & Swiss Franc
Russell points out something which seems extremely relevant to any investor in gold and that is the relationship between gold, gold stocks and the Swiss franc.  Russell says the following:
“Now here’s what nobody (or let’s say very few people) know.  If I asked you “How’d you like to own Swiss francs at the early-1974 price?”  you’d probably jump at the chance.  Why would you jump?  Because the Swiss franc has been a hot item, a glamour currency.  Look at my next chart (bottom of p.5).  Note that the Swiss franc was about 31 cents in early-1974.  Gold at that time was $166 per ounce.  All right, the franc is now 45 cents or about 45% above its early-1974 price, in terms of dollars.  But gold is roughly the same price as it was in early-1974!  Now what the hell makes the Swiss franc better than gold?  The irony is that the Swiss franc is highly valued because it has such a high level of gold backing.”
Nothing could be more instructive than the review of the price of gold, gold stocks and Swiss francs during what was perceived to be a gold bull market. Few gold bugs will acknowledge the amazing decline in the price of gold from early 1975 to the low of 1976.  The decline was nearly 50% of the peak price and lasted nearly two full years.  Likewise, the Barron’s Gold Average lost nearly 66% from the high achieved in 1974 to the low near mid-1976.  The Swiss franc, on the other hand, remained in the a narrow trading range or moved higher.
Russell was correct to question “…what the hell makes the Swiss franc better than gold?”  Although Russell never mentions it, by pointing out the “uncharacteristic” rise of the Swiss franc at the time, we gathered that the activity of the Swiss franc implies that it is an indicator for the longer-term price of gold.  Because we’ve pointed out in many previous articles the fact that gold isn’t always the safe haven that it is fabled to be, when the next big decline in the price of gold occurs we will be watching closely the action of the Swiss franc for any indications of investment opportunities in gold stocks.  We have constructed what we believe to be a reliable indicator for the best time to buy gold stocks that are constituents of the Philadelphia Gold and Silver Stocks Index.  The action of the Swiss franc will act as a confirming indicator when the index is near a new low.
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Richard Russell Review: Wrong About the Industrial Production Index

Posted on June 12, 2011 by | Leave a comment
On June 6th, Richard Russell wrote an article on the Financial Sense website titled “Are We Fated to Live 1929-1930 All Over Again?” In that article, Russell discussed the Barron’s Monthly Index of Physical Volume of Industrial Production [BMIPVIP] reflecting on the movements of the index as compared to the Dow Jones Industrial Average in the period from the peak of the stock market in 1929 to the bottom in 1932.

Richard Russell pointed out that from November 1929 Barron’s Monthly Index of Physical Volume of Industrial Production [BMIPVIP] gave ample warning that the direction of the U.S. economy was still headed lower despite the rebound of the Dow Jones Industrial Average from November 1929 to April 1930 as depicted in the chart below.

Source: Persons, Warren. Barron's. May 15, 1933; pg. 18
Because the BMIPVIP was discontinued in 1938, we’ve used the closest approximation which is the Federal Reserve’s Industrial Production Index (INDPRO) found at the St. Louis Federal Reserve website.  In order to make a comparison to the two indexes, we checked the performance of the INDPRO to the BMIPVIP.  Below is the chart of the Barron’s adjusted and unadjusted BMIPVIP index and the Federal Reserve’s INDPRO from 1919 to 1933.

 It can clearly be seen that the Federal Reserve’s index (INDPRO), which is still in use today, can be used to measure against the Dow Jones Industrial Average.  Whenever the Barron’s index zigged the Fed’s index zigged, whenever the Barron’s index zagged so too did the Fed’s index.  We believe that using the Fed’s Industrial Production Index is the best and most consistent approximation to compare to 1929 to 1934 (shown below) as well as today’s market.

source: Person, Warren. Barron's. May 15, 1933. pg. 18.





According to Russell, the BMIPVIP hit its high in the month of June 1929.  This was a full 3 months before the peak in the Dow Industrials in September 1929.  The Federal Reserve index actually peak in July 1929 however, this was still ample enough time to gain inferences from the index’s movement.

Russell correctly observed that the BMIPVIP was critical in the evaluation of whether or not the economy and the stock market were on a rebound.  The great Dow Theorist Robert Rhea first introduced the use of Barron’s Industrial Production Index in his book Dow’s Theory Applied to Business and Banking.  Rhea used BMIPVIP as a means to confirm the signal provided by Dow Theory which contributed to his accurate call of a market bottom in July 1932.

Richard Russell’s point was that even though the stock market rallied strongly after the initial crash from the September 1929 high to the November 1929 low, the subsequent rebound was unsustainable when viewed from the perspective of the BMIPVIP or the INDPRO.  Unfortunately for Russell, his analysis of the BMIPVIP index and the Dow Jones Industrial Average comes to the wrong conclusion when attempting to bring actions of the past to market activity of the present.

Russell closes his article with the following thoughts:

“After April 1930, the post-crash rally ended, and a great bear market began. As the market turned down again, the US economy crumbled. By July 1930, Barron's Index of Industrial Activity had fallen to 85.5. The Great Depression was on.

“And I'm wondering about the comparison with today's action. Recently, we've seen the Dow climbing steadily from its March 2009 low, all the while with the economy neutral to weak. Then we see the Dow hitting a high last month in May with business today sluggish and even weaker than it was in January.

“And I'm wondering, ‘Are we fated to live 1929-1930 all over again?’ Is the stock market rally of March 2009 to May 2011 a repeat of the stock market rally of November 1929 to April 1930? In both instances, business weakened as the market climbed higher.

“But the scary part is that in 1930 when the Dow broke support, the Great Depression began and Barron's Business Index continued to plunge. Let's keep an eye on the March 2011 lows -- Dow......11613.30 and Transports ....4950.17.”

We’re disappointed that Russell’s remarks are uninformed and misleading with the intent of creating fear. First, Russell withholds the data necessary to test whether his assessment is accurate. Next, Russell implies that the Dow Industrials of today may be rising in spite of the Industrial Production Index falling. However, the Fed’s INDPRO has been in perfect alignment with the rise of the Industrial Average since 2007 as shown in the chart below.

Finally, Russell closes his article with an attempt at drawing the events of the past to the present.  Russell's effort lacks all substance when he speaks of targets for the Dow Industrials to watch for but doesn't introduce the Industrial Production Index nor it's relationship to 1929 and today. 

While the true test may come when the Dow Industrials and Industrial Production Index (INDPRO) attempt to exceed the prior high of 2007, there is little indication that Russell’s assessment is correct.

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Richard Russell Review: China in the ’60s

Posted on August 17, 2010 by | Leave a comment
The genius of Richard Russell can be found in his ability to observe.  At least 30 years before China was on the lips of yet to be born hedge fund managers and venture capitalists,  Richard Russell was providing clarity on the future of China while it was in the throes of Communist power.  The following are excerpts of Russell's commentary on China during the 1960's.  Russell himself never touts his record on his prescient views specifically on China, consider this among the first.

July 25, 1962. Issue Number 188. page 4.
In this issue, Russell compares the conventional wisdom with what ultimately became the outcome which tended to be counter, or opposite, to the prevailing view. One comparison that was made was from the period of 1958-1961.  Russell said: “Russia [was] way ahead of U.S. in space. Communists taking over the world and apparently unstoppable. Everything [was] going Russia’s way.” The final reality was that by 1962 “Russian space progress greatly exaggerated. Russia runs into economic trouble. The rise of China as the possible great threat.”
May 25, 1965. Issue Number 289. page 4.
“A fascinating aside on the gold picture is the news that Red China has now joined Russia as an interested accumulator of gold. According to the New York Times, China has recently purchased over $60 million of gold through the London Gold pool.”
December 21, 1965. Issue Number 309. page 2.
“A strong, competitive, aggressive country tend to accumulate gold, while a country which is plagued by inflation, rising costs, ineffective budget control and political ineptitudes tends to lose gold.”
December 21, 1965. Issue Number 309. page 4.
“China obviously wants to prolong the war [with Viet Nam], and it is this writer’s opinion that China sees the war as part of her economic battle with the U.S. China knows that continuation of the war will have the effect of bleeding this nation dry.”
January 11, 1966. Issue Number 311. page 2.
“As I see it, China is very much afraid of war with the U.S. (see Sundry Comments), and the fact is that China has backed away from real confrontation with the U.S. whenever that possibility has arisen. On the other hand, I believe Russia would like the keep the war expanding in the hopes that the U.S. will ultimately turn her nuclear capabilities against China (note the reports of new giant Russian-made mortars in the hands of Vietcong). If Russia can bring this off, she will have rid herself of the Chinese nuclear and population explosion threat, and she will have emerged as the second or greatest power on earth.”
February 1, 1966, Issue Number 313. page 2.
“It is well to remember that the Communists (ironically) view capitalism from an orthodox (pre-Keynesian) standpoint, and the Chinese in particular have always been fiscal conservatives.”
 “An interesting aside is that renewed gold buying has come in from Red China (in the London Market). This prompted the London Economist to note ‘The buying represents not a switch out of sterlings, but out of Swiss francs. China has apparently been accumulating them in greater quantity than was generally suspected.’ This gold buying fits in with the writer’s thesis that China is fighting an economic war with the U.S., and that she wants ultimately to compete with capitalism in the marketplace. China’s unannounced motto might be, ‘Keep buying gold while the U.S. loses her own gold.’”
September 21, 1966, Issue Number 335. page 3.
“The Third World force is to be China, the looming giant of the East. In time, thinks DeGaulle, the buffer force will be ‘cemented’ and grow powerful, in time China will be a superpower to be reckoned with…”
“Russia and China are fully aware of the power of the yellow metal, and both are making every effort to bolster their holdings. The scene is set for drama over Africa. But in this writer’s opinion, history will favor those who understand the old adage, ‘Gold will win.’”
February 17, 1967, Issue Number 349. page 2.
“…Russia wants the war to continue, since it keep the U.S. ‘aimed’ continually at Russia’s real enemy, China.”

 
As with the first entry on July 25, 1962, it may be necessary to reflect on the conventional wisdom to determine if things going forward may not turn out as many analysts expect. 
 
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Richard Russell Review: Letter 762

Posted on July 20, 2010 by | Leave a comment
Letter 762 was published on August 1, 1979. At the time, the Dow Jones Industrial Average was indicated at 839.76. There were a couple of items that stood out as I read this newsletter.
Richard Russell said:
“As a matter of fact with Libya’s recent 10% cut in oil shipments and Algeria’s just announced 20% cut, I suspect that there’s an oil (and gas) glut building up now! The world is learning to cut back on fuel use—and fast, and this could turn out to be the shocker of 1979-1980.” Page 2.
In fact, it wasn’t long before oil prices reflected the glut that Richard Russell spoke of. Under normal circumstances, it would be difficult to see beyond the present crisis and think that it will end at some point. It seems that Russell was cognizant of the prospect, as remote as it seemed at the time. Unfortunately, as indicated in the chart below, $15 oil would become a base, or floor, instead of a ceiling.
One item that has been a longstanding issue with Richard Russell is reflected in the next quote.
Russell said:
“Last week I was asked this question: ‘Russell, if you could change any part of your stock approach over the past year, what would have done?’ My answer was, ‘There are many subscribers who are willing to speculate, and I think I have been too conservative and too stubborn on this issue. The change I would have made is that I would have offered speculative choices for those willing to assume the risk of buying in a market that is not over-sold and not in an ideal buying area.’” Page 2.
In addition to the previous remark by Richard Russell, he also said:

“I want to add that I personally am buying no shares here. I prefer to wait for the ‘ideal buying situation.’” Page 2.

The two remarks above have been the biggest challenge to Russell’s ability to adhere to Dow Theory or even his Primary Trend Index which was created to avoid potential market manipulation. Russell is infinitely waiting for the “ideal buying situation” while ignore individual values along the way.
Russell points out a fact that every investor should have ingrained in their mind before committing a single dollar to the stock market or any other potential investment opportunity. Russell said:
“Every investment must ultimately be valued on its return. In the stock market that means dividends. Ultimately, dividends must be paid if a stock is to be worth anything.” Page 4.
I thought that the following remark was profound.
“Now here’s an interesting aside on inflation. One of the reasons it’s so insidious is that as soon as a man starts protecting himself against it, as soon as he buys a house or a load of gold coins or a painting or a stamp collection-that man wants his inflation hedge to go up. He becomes (deep in his heart) an inflationist. Take housing: the value of total housing in this nation is $2.2 trillion (two thirds of these houses have mortgages). The last thing these home-owners want is a declining market. They are secretly in favor of rising prices and inflation.” Page 4.
Russell’s comment is right on target when it comes to the attitude of most people. It seems that everybody is an inflationist. There are few market participants or commentators who express the view that they hope their long position will decline in value. The NLO team happens to be among the few who, after going long a stock, are eagerly anticipating a decline in price. Shameless self-promotion aside, Russell’s commentary on the closet inflationists is truly profound.
Russell points out that if you’re in commodities but not in precious metal then you could be losing your shirt. Russell says:
“Commodity traders have had one of their roughest seasons in years. If you weren’t in the metals, you probably ‘got killed.’ For instance, the October cattle contract is now down from 74.45 to 61, a drop of almost 18%. One trader told me that ‘it looks like the country is vegetarian.’ Live hogs are much worse, with the October contract dropping from 51 to 32 a drop of 37%. On piggies I was told that they act like ‘the whole world is going Jewish!’” Page 5.
This counters the belief that during inflationary periods, all commodities do well or go up in value. It should be noted that the declines that were mentioned by Russell could have been the equivalent of a temporary pullback or secondary reaction. Interestingly, monthly hog prices traded in a wide range from 1972 to 2004 as indicated in the chart below. Suffice to say, anyone involved in commodity trading should be willing to accept even greater losses than the 50% that we expect for long positions in stocks before seeing any gains.
On the topic of interest rates Russell says the following:

“To the casual observer, it looked like a world embroiled in an interest rate war. And the fact is that rising inflation is being fought all over Europe and Japan- via an interest rate squeeze. The US is a frightened and reluctant follower.

“A few weeks ago Germany raised her bank rate. At the same time Britain boosted her borrowing rate a whopping 2%. Last week the US raised its discount rate an insufficient .5% to a record 10%. Canada immediately followed with a boost to 11.75% in her bank discount rate. The Japan jumped her lending fee to institutions a full 1%.” Page 5.
My thoughts on this passage are that it seems fascinating that the US wasn’t taking the lead in interest rate policy. Especially in comparison to the countries that were mention. It may have been a purposeful attempt to adjust rates when it was absolutely necessary. Could you imagine interest rates jumping 2% at a time?
Russell indicated that as the world’s leading power, the U.S. with its excessive printing of dollars cannot continue unabated. Russell said that foreign holders of dollars would become anxious and “move towards the exits.”
Russell mentions the Gold/Stock ratio; which divides the price of gold by the value of the NYSE Composite. Of the rising trend of the ratio, indicating strength in the price of gold, Russell says:

“Day after day the ratio climbs higher, and it is clear to me that shortly, SOMETHING IS GOING TO GIVE.” Page 5.

With hindsight being 20/20, my thought is that what “gives” in this situation is high inflation unless Russell was proposing that all governments are going the way of hyperinflation. My observation is that what tends to break, when two normally divergent indicators are going in the same direction, is the one that appears to be the “strongest.” In this case the stronger component of the Gold/Stock ratio was gold which had been in a multi-year rising trend while the NYSE had been in a wide trading range for an extended period of time.
I do have concerns about the sensibility of a gold/stock indicator since I have presented the view that gold and stocks usually follow each other rather than move counter to each other. For the most part, we have seen gold lag on declines and lead on rises in the stock market. One thing I’m certain of, if the price of gold rises then the stock market isn’t far behind. There may be an occasional divergence but the overall picture is that gold and stocks generally move in unison.
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Dow Theory and Richard Russell

Posted on July 11, 2010 by | Comments Off on Dow Theory and Richard Russell

In attempting to understand Dow Theory it is necessary to follow the best and the brightest on this topic. Over the last 52 years, the brightest person on Dow Theory has been Richard Russell. No single person has been more outspoken on their views on the market using Dow Theory, uninterrupted since 1958, than Richard Russell. So when Richard Russell does an about face on his interpretation of Dow Theory it is worth our time to examine the reasons.

First, it is necessary to provide context around the ideas on Russell’s most recent market call.

  • From November 12, 2007 to January 2, 2009, Russell indicated that we were in a bear market. The Dow went from 12,987.55 to 9,034.69, a decline of -30.44%.
  • From January 5, 2009 to January 12, 2009, Russell indicated that we were in a bull market. The Dow went from 8,952.89 to 6,926.49, a decline of –22.63%.
  • From March 11, 2009 to July 22, 2009, Russell indicated that we were in a bear market. The Dow went from 6,930.40 to 8,881.26, a gain of +28.15%.
  • From July 23, 2009 to May 19, 2010, Russell indicated that we were in a bull market. The Dow went from 9,069.29 to 10,444.37, a gain of +15.16%.
  • From May 20, 2010 to July 8, 2010, Russell indicated that we were in a bear market. The Dow went from 10,068.01 to 10,138.99, a slight gain was registered for the period (<1%).

On July 9, 2010, Richard Russell said:

“When the facts change, I change. To do otherwise would be idiotic. Something occurred yesterday that made me sit up and take notice. We had the non-confirmation by the D-J Transportation Average, a situation that I discussed on the July 5 site.”

“Following the Transport non-confirmation, yesterday the market surged higher, Dow up 274 and Transports up 152. But that’s not all. What I noticed was that yesterday was a 90% up day [up volume versus down volume] — the formula for a bottom.”

According to Russell, the Transports non-confirmation along with a 90% up volume/down volume ratio is what led to the conclusion that the market was indicating that a bottom was in. Russell goes on to recommend buying various ETFs with stop losses. Several problems arise when market action is viewed from Russell’s perspective.

First, Russell has ignored the fact that a trend is in place until a counter trend is signaled. So far, we haven’t had a bear market indication since the March 9, 2009 low. If the Transports were to confirm the Industrials by falling below the February 5, 2010 low, then we’d have our first bear market signal.

Second, when thinking in terms of Dow Theory, market participants have three variables to consider the Dow Jones Transportation index, Dow Jones Industrials and NYSE volume. Volume attributes are considered over a period of time. Single day action on volume should not be the determining factor for considering a bull or bear market. If this is the case, then most market signals could be very misleading. In my observations, market volume has increasingly become an addendum to Dow Theory.

Third, Russell has often disregarded the pure Dow Theory indications that have come along the way since the March 2009 low. It seems that Russell’s understanding of macro issues and his personal experience in the markets has led to his decision to err on the side of caution. However, Russell’s cautious streak has usurped the value of Dow Theory to act as a “…composite index of all the hopes, disappointments, and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly discounted in their movement. The averages quickly appraise such calamities as fires and earthquakes.” (Rhea, Robert, The Dow Theory, page 19).

Next, Russell has set himself up for the need to change his analysis by not thinking through Dow Theory to its conclusion. By calling a bottom at this juncture, Russell has left out the all-important confirmation that is required by the Industrials and Transports. 10,450.64 and 4,467.25 are the new levels that the Industrials and Transports need to surpass before any buying policy should be considered. In addition, after surpassing the referenced upside confirmation points, the next level of resistance is 8% away for both indexes. This means that we could go to the old high and then quickly reverse to the downside if a bull market confirmation isn’t signaled. However, given the most recent market action, our focus should be on the confirmation of the reversal pattern first, then the possible bull market indication.

Another matter of concern is that Richard Russell makes recommendations that don’t address the issue of investing in values. Values are a core tenet of Dow Theory. In fact, when you read Dow Theory Unplugged or Charles H. Dow: Economist, you will find that values, not technicals, are espoused. Russell points his readers to speculative opportunities instead of undervalued stocks which can be held for “the long term” if the bullish assessment happens to be incorrect. Our list of Dividend Achiever stocks at or near a new low addresses the prospect that if we’re wrong there is some recourse. In this case, you get the ability to compound your investment over time with the prospect of capital appreciation.

Finally, our stance on stop loss orders is widely known as indicated in the article “Automatic Orders Don’t Provide Protection” as well as our disclaimer at the end of each sell recommendation. Russell’s recommendation of buying ETFs is reckless at best especially in light of the May 6, 2010 “flash crash.” Adding fuel to the flames is the article titled “ETF ‘Circuit Breakers’ Needed to Stop Flash Crashes: Pros.” Our stance on ETFs is well founded and preceded any discussion of the true risks associated with them on May 6th (“ETF: Mediocrity With No Pretense of Value” and “ETF: Indiscriminant Risk”).

It is likely that perma-bulls will seize on the Russell commentary of July 9th as the heralding of a new-new era in investing. On the other hand, “contrarian investors” will suggest that when Richard Russell, perma-bear that he is, has entered the bull ring then the bull run is definitely over. It is our contention that while Richard Russell might be right about a reversal pattern being in place he is not using Dow Theory.

Our latest views on Dow Theory can be found at the following link (NLO on Dow Theory). Keep in mind that all trends are considered to remain in place until otherwise indicated. So far we are still in a cyclical bull market within a secular bear market

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Richard Russell Review: Letter 742

Posted on July 6, 2010 by | Leave a comment
Dow Theory Letters issue 742 was published on November 1, 1978. At the time, the Dow Jones Industrial Average indicated was at the 806.05 level. In this issue, Richard Russell discusses several topics that are very important to every Dow Theorist.
First, Russell states that:
“…history shows that when bull (or bear) markets really begin, Dow Theory signals are generally greeted with derision, skepticism, and scorn-rather than wholesale agreement!” page 1
This comment is in response to the Dow Theory bull market signal that was given on August 2, 1978. In this case, Russell felt there wasn’t enough skepticism by market participants to warrant a need to trust the signal. I’m guessing that after 12 years of a secular bear market any good news about the market would appeal to the glass half-full crowd.
Letter 742 also has a chart (located here) of the Dow Jones Industrials, Transports, Utility Averages and NYSE volume. Upon closer inspection of the chart below, ranging from March 28, 1978 to October 27, 1978, you can find two confirmations of a bull market and one confirmed bear market indication as part of Dow Theory.

According to Russell, point A (August 2nd), on the Dow Industrials, was a false secondary peak or bull market indication. However, it should be noted that when the Industrials went above the June 29th peak of 821.64 (point A1) on July 21st it was a clear indication that the index was going to retest the previous high at point A.

After the bull market move upward a bear market indication was given when the Industrials and Transports fell below point B1 that corresponded to the August 31st low of 876.82 and 248.78 respectively. A bull market non-confirmation was indicated (red circles) in the fact that neither index could exceed the high of September 8, 1978.
Let’s do the math for a moment, point A1 gave a buy signal plus point A’s confirmation of the buy signal equaled a 9.62% rise by the time the market gave the bull market non-confirmation at Dow Industrials 900. The same timing applied to the Dow Transports would have equaled a gain of 13.64%. To my mind, this was in line with our view that any return close to 10% in less than a year is an acceptable amount to trigger a sell of any stock.
Russell also repeats a common attribute that he seeks in the market before considering going “all in.” Russell says:

“I noted that every bull market in history had started from an over-sold base, but that this market had not seen a over-sold condition since late-1976.” Page 1.

In this remark, I have two thoughts that immediately come to mind which is reflected in the chart below. The first is that even after the 1974 bottom there was another time (1976) that was “most ideal” to buy stocks at over-sold levels, according to Russell. However, even though late-1976 was experiencing oversold conditions, it certainly didn’t mean that further declines were out of the question. After the ’76 bottom, the Dow Industrials had a short rally and then fell as low as 742.12, a decline of 19.69% from the 1976 lows, by February 28, 1978. Finally, the view that an over-sold base is a condition necessary for a bull market may not be accurate.

On page 2 Russell said:

“Right now, I want all my subscribers to stay out as per my instructions in Letter after Letter.”

This suggests that after the January 1975 buy signal given by Russell, it was very difficult to keep a long-term position even though it was the absolute best time to “buy and hold” stocks.

“The violence and rapidity of this smash has few precedents in stock market history.” Page 2.

When calculated to the November 14, 1978 low, the decline from September 8, 1978 equaled a drop of 13.5%. To me this doesn’t seem like all the much of a decline.

“Somewhere in the period ahead, we are going to see the real ‘third phase bear market action’ in the Dow and most other stocks. True, during 1973-1974 the majority of stocks were pulverized in a slide that was comparable to 1929-32 in many ways. But the Dow lost less than 50% of its value at that time. My guess is that before the third or final phase of this bear market is over, we are going to see the Dow at drastic new lows, we’re going to see dividends cut across the board, we’re going to see very high interest rates, and we’re going to see something that this generation has never seen before-wholesale liquidation of debt in all sections of the economy, private, corporate and perhaps even government.” Page 2

“Each time it looks as if the ‘plug is going to be pulled,’ the bear market (with the help of huge infusions of monetary inflation from the Fed) pulls itself out of the hole.” Page 2

Russell was waiting for the third phase of the bear market. According to Russell, the Fed was holding the market up with the trade-off being higher inflation. My thinking is that a crash didn’t occur simply because the Fed was willing to accept higher inflation as a substitute for a crash. In addition, if the markets were to get a crash and record inflation at the same time it would be exceptional situation. The third phase decline that Russell expected never seemed to materialize on the scale of 1973-74 or greater.
Other Notes in Letter 742:
  • E. George Schaefer’s investment performance from 1949 to 1966.
  • James Dines book the “Invisible Crash”
  • MC Horsey’s chart of an inflation adjusted Dow since 1960
  • Benjamin and Herbert Stein’s book “On the Brink” with reference to, of all things, the Chinese cornering the gold market
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Richard Russell Review: Letter 745

Posted on July 4, 2010 by | 1 comment
Dow Theory Letters Issue 745 was written on December 6, 1978.  At the time, the Dow Jones Industrial Average was indicated to be at the 811.42 level.  What stood out the most to me was the fact that Richard Russell made very clear commentary on the price of gold and the direction of stocks.  Russell made the following commentary:

"It [gold/stock ratio] is telling us that for the foreseeable future (until the next signal), if we do anything we should do it in stocks." page 3.

Anyone familiar with the stock market in 1978 would know that if you had bought a handful of stocks and didn't sell them until 10 years later you would have had a compounded annual growth rate of 8.73% (this takes into consideration the crash of 1987).  Russell's comments on being in stocks would have seemed to be very much on target.  However, it is his aversion to gold at this time that seems to contradict his earlier comments on gold.
In Letter 742 dated November 1, 1978, Richard Russell said the following about gold:
"Slowly, very slowly, it's dawning on the world that we're witnessing one hell of a bull market-in gold. I've been writing pages and pages about gold in each Letter, trying to get new subscribers in the metal (or the coins), trying to get older subscribers to STAY in gold.  Happily, a large percentage of my subscribers are now sitting with large gold positions.  And the paper profits (in terms of dollars) are mounting." page 5.

This commentary seems odd because in Letter 745, Russell goes on to say:

"At any rate, it is a bearish omen when the [gold] open interest stays high in the face of a persistent decline, and that is what has occurred." page 6

Russell called himself to task by asking the following question:

"Question: Russell, you were so hot on gold a few months ago.  Gold was 'real money,' you said.  Gold 'would save the system,' you said.  How can you just "turn off" on gold?
"Answer: I haven't turned off on gold, I've turned off on gold at this time.  The market isn't like your wife or your daughter who you love through thick and thin.  We're dealing here with correct procedure and purchasing power.  The fact that I advocate gold-backed currency has nothing to do with the fact that I think gold is in a bear trend over the coming months.  In this business, you had better learn that the trend makes you the money, not the item.  I'd rather buy Cesspools, Inc. if that stock was going up than IBM if IBM is heading down." Page 7
In retrospect, we know that gold went as high as $850 an ounce in January 1980.  However, it is interesting to me that Russell said that a bear trend was approaching "...over the coming months."  In Letter 745, Russell included a chart that compared the London Gold to the Gold Stock Average.

 

Russell's favorable comments of gold on November 1, 1978 were well off of the highs from the prior month.  However, since Russell was a practioner of Dow Theory and was using the London price of gold along with the equivalent of the XAU gold index to act as a confirming mechanism for the future price of gold, it should have been considered that because the London price didn't fall to the corresponding low set in April of 1978 that there must have been a non-confirmation of the downside trend.  Instead, Russell said the following:
"The GSA [Gold Stock Average] has collapsed, and is now down to its previous low for the year recorded last April.  Bullion has obviously held up better than the gold shares, but so far the downside non-confirmations by bullion have failed to halt the decline.  This kind of action is always indicative of a weak market, and it just seems that there are still too many optimistic gold-holders around." Page 6.
Is it possible that the gold shares are held by the public and speculators (weak hands) and the bullion is held by investors and "institutions" (strong hands)?    Somehow I think this relationship has some value.  I'm just not sure if Russell called this intermediate move correctly.  So I decided to search for an updated version of the London Gold and GSA comparison.  Below is what I found in the July 5, 1979 issue:

 

It should be noted that the exact bottom in the price of gold and gold stocks (red circles) coincided with the publishing of the December 6, 1978 Letter 745.
Also Worth Mentioning:
  • Russell said that "Greed and options don't mix."  My impression on this remark is that I always thought that the purpose of options is to get exaggerated gains with the trade-off being no equity.  Seems to me that greed and options go hand in hand.
  • Dow Theory Letters are available at http://www.dowtheoryletters.com/
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