Dow Theory Update for April 21: The mother of bear markets and the Dow Theory

Revisiting Russell’s bearish stance under the prism of the Dow Theory

In my last post, which you can find here, I explained that Richard Russell of the “Dow Theory Letters” thought that the mother of bear markets might be in the making. I gave several reasons whereby I thought such a statement is not sufficiently substantiated.

I finished my post by writing:

"If stocks enter a primary bear market (even the “mother of bear markets” one as Russell suspects, the Dow Theory will manage to get us out early enough. If history is to serve us a guide (a very rough one, granted, with no forward assurances) we shouldn't lose more than 10% from the market top."

Last weekend I thought that my last statement deserves further explanations in order to assuage those still worried by the “mother of bear markets”.

First of all, let’s be frank. If tomorrow the market gapped 40% down, not even the Dow Theory would save you. If an earthquake destroys all the West Coast or a meteorite hits the Earth (something which might occur), then all bets are off. The market will tank overnight, and there is nowhere to run. However, if a meteorite hit the Earth, gold wouldn’t be of much avail either. So if something cataclysmic happened, neither the Dow Theory, nor “buy and hold," nor even gold would help us much. Can such a sudden catastrophe happen? I really don’t know, but I do know that I cannot base my investment decisions on betting that the world will almost end tomorrow.

Please bear in mind that Russell has been betting of something nasty happening from time immemorial (with bullish episodes in between) and has accordingly missed a great chunk of the ongoing bull market.

On the other hand, if a sudden devaluation of the USD might occur (something which definitely could happen), the most likely outcome would be stocks soaring, so the “gap” would tend to be bullish rather than bearish. So if the dollar got trashed we would see a bullish market (which hopefully would keep the purchasing power in real terms intact), not a bear market. This scenario is perhaps underlying the ongoing bull market, which, all doomsayers notwithstanding shows its resiliency day in day out. Is the stock market anticipating the gradual (or sudden) demise of the USD? It might seem so if we are to follow the charts.

Barring a sudden overnight “gap”, then the “mother of a bear market” should be a sudden crash or a deep and protracted bear market. Two such episodes come to my mind: the 1929 and the 1987 crashes. I feel we can label such two bear markets as “the mother of bear market”. I have in the past analyzed how the Dow Theory managed to leave investors unscathed. Here is what I wrote:

“[t]he Dow Theory managed to get investors out of stocks before the market crash. In other words, a sell signal (primary bear market) was flashed shortly before the crashes began in earnest. Here you have the details of the two positions which preceded both crashes:

             Day/Month/Year    Price Indust    Pctg gain

BUY	07/12/1923	93.8
SELL	23/10/1929	305.85	226.07

BUY	21/01   5	1261.37
SELL	15/10/1987	2355.09	86.71

As you can see in both instances, the investor was forewarned on time by the Dow Theory. Furthermore, in both cases, the investor managed to lock in sizeable profits (226.07% in 1929 and 86.71% in 1987). You can find more details about the remarkable job the Dow Theory did in 1987 in my post “Revisiting the 1987 crash," which you can find here.”

 

Furthermore, if you go to this exhaustive post, you will see that the Dow Theory (especially, Schannep’s flavor) has the uncanny ability to get investors out of trouble roughly 10% below the market top. Thus, while no forward assurances can be made, the very structure of the Dow Theory signals will take care of getting us out of danger soon enough.

This is why, with all due respect to Russell, I really cannot agree with him. If the “mother of bear markets” comes, then we will be exited in time.If the world ends tomorrow, then I couldn't care less about markets.

US Stocks, gold, silver and their miners ETFs.

Primary and secondary trends remain unchanged. Precious metals look weak and should stage a rally soon or else….

Sincerely,

The Dow Theorist