Wednesday, September 19, 2012

Plain vanilla Dow Theory? Or does Dow Theory come in many flavors? II

Part II. Richard Russell and his Dow Theory Letters.

Russell is a living legend. He is greatly influenced by Schaefer but, in my opinion, Russell is more pragmatic and, without meaning disrespect for Schaefer, a more rounded up Dow Theorist and investor. If you read Schaefer’s book you’ll see that, under the guise of subtle criticism, he really believed that his “New Dow Theory” was the orthodox Creed and that Rhea and Hamilton were wrong. Furthermore, he hints in his book that they might have psychological issues because they relied heavily on a “system”. However, Schaefer failed to see that thanks to a “system” Rhea, and to a lesser extent Hamilton, had clear rules that told them when to run for the exits. In a secular bull market, such as the one experienced by Schaefer from 1949 to 1960 when he wrote his book, a “system” may look superfluous because the rising secular tide poses no real threat to one’s capital integrity. However, when a really vicious bear market sets in, the investor needs “rules” or a “system” to get him out. Capital protection is the first rule. One needs a yardstick to know when “enough is enough”. Absent the yardstick your losses are open-ended.

Schaefer provided very useful insights, though; insights that the old pragmatic Russell integrated into his own flavor of the “Dow Theory”. However, after having read Russell’s book and most of his Dow Theory Letters dating back from 1958, I can see that Russell is a very intelligent man. Too intelligent to proclaim that “his” Dow Theory flavor is the only right one. By the way, if you are serious about learning Dow Theory and, more importantly, how to think like a successful investor, you can get all the Dow Theory letters published by Russell  here 

Thus, Russell’s flavor of the Dow Theory doesn’t lend itself easily to be cataloged. I can safely say that Russell pays lot of attention to values and tends to invest along the secular trend (here being a follower of Schaefer) whenever possible. However, he’s got a built-in survivor instinct which makes him heed the technical warnings of the Rhea flavor of the Dow Theory when needed. Thus, if you google “Dow Theory Letters” you will see that his website tag reads “Follows the Dow Theory market timing system. Well, this emphasis on “timing” has a distinct Rhea smell. We could say that Russell’s Dow Theory is a very flexible one. He tries to side with the secular trend, but he is not oblivious to the cyclical bull and bear markets that occur within it. Unlike Schaefer, he will not doubt to run for the exits if the technicals convince him that, in spite of valuations, the market structure signals a primary cyclical bear market. Furthermore, Russell follows the motto “when in doubt, stay out”, so he always errs on the side of caution.

Furthermore, Russell is a man with a very big picture. His “advice” does not merely relate to the stock market but he also actively recommends his subscribers to invest in gold (when the time is right, as now) and even diamonds. He is a seasoned investor with good knowledge of economics. And he’s an excellent writer. He knows his craft.

His latest great call was in 2008 when, according to the Rhea “flavor” of the Dow Theory, he advised investors to get out of all stocks because a primary bear market had been signaled by the Dow Theory. This market call was the turning point for me to become much more “technical” than “fundamentalist”, since I saw firsthand the way many “fundamentalists” got killed by the bear market. This was especially so, when, after reading Russell and after filtering him with my own understanding of the Dow Theory, I was convinced that an ugly primary bear market had begun. Thus, on his Letter 1437 of March 19, 2008 he wrote:

“I just read a four-page treatise by a very successful analyst in which he demonstrates based on the fundamentals, why the economic situation in the US is basically healthy. This analyst may be absolutely correct, and I’ll admit I was impressed by his analysis – but I trust the market more”.

(emphasis mine)

The old fox Russell knew better than the analyst.

Russell’s uniqueness, makes evaluating his track record an elusive task. Do we count gold in the mix? Only stocks? After studying him intently for many years I can only say that those that followed his advice (including of course buying gold since the early 2000’s) have fared very well. My BOE calculations tell me that his performance in the last 10 years may have averaged ca. 10% and more importantly, he helped us keep our powder dry when the tough times (2008) came.

Russell also developed in 1969 the so-called Russell’s “Primary Trend Index” (PTI). While not being this index strictly based on the Dow Theory it served Russell well. Such index which tries to gauge the primary trend of the stock market has shown an uncanny ability to be on the right side of the market and as Russell himself says “the PTI is smarter than I am”. While providing hints as to the composition of the PTI, Russell keeps secret its specifics. Of course, Russell’s PTI has nothing to do with the Dow Theory and it is merely a timing indicator.  Personally, I don’t use Russell’s PTI because I cannot trust an indicator whose details are unknown to me. I don’t like “black boxes” even if they come from reputable investors. As of this writing, whereas Russell is bearish on stocks (but bullish on gold), his PTI has been stubbornly crying “bull market”.

By writing this eulogy of Russell I am not meaning he’s always right. Dow Theory is not an exact science. But the mark of a good Dow Theorist, or any investor for this matter, is not to be “in the money” in each market forecast but rather, after long time periods (let’s say 10 years) protect his client’s capital and, if possible, help them achieve positive returns. Thus, in the rare occasions he’s not on the right side of the market, he’s intelligent enough not to have an ego and to change gears when subsequent market action proves him wrong. As a consequence, his flexibility results in avoiding serious damage to his followers.

While my overall assessment of Russell is very positive, I don’t mean I always agree with him. On several instances, and after having followed him for many years, I didn’t agree with his analysis and conclusions. This is precisely what prompted me to become a Dow theorist myself. To put money on the line I wanted to develop my own independent judgment, even though I continue to read Russell to this day. I wanted to be able to analyze the market by myself without needing Russell’s Dow Theory letters crutch. But this is the subject for another post. 

The next Dow Theorist in our "Hall of Fame" is Jack Schannep whose website you can find here. We will talk about him in Part III of this saga.

To be continued .


The Dow Theorist

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