Most weeks we discuss anecdotal evidence that we have seen firsthand or heard from business contacts and friends about why the economy is moving in the right direction. Readers have heard us mention everything from a distressed real estate market leading to value buys, to automotive sales being too high to support the theory of a recession, to manufacturing shifting back to the United States from overseas. This week we wanted to cover some technical data that validates our beliefs.
While we rely heavily on evidence “from the horse’s mouth” of our contacts, there are a handful of newsletters that we read, strictly for alternative input and to hear what other money managers are thinking. We have quoted John Mauldin on several occasions, John Hussman and even Peter Schiff of Euro Pacific Capital, but another that we follow is Richard Russell and his Dow Theory Letters. He provides a unique technical perspective on investing that we all enjoy reading. In his December 5th letter, he made the case for a bull market run, a case that we have been making for over a year now.
The Dow Theory was developed by Charles Dow in the late 1800s as a technical way of predicting the markets. There are 6 basic facets that apply to this theory, which detail everything from how market prices are determined by the sum knowledge of all participants, stages of market cycles, related averages confirming one another, etc.
One aspect Russell tests is the “50% rule.” The thought is that since the Dow Jones Industrial Average was valued at just over 14,000 before the market decline in 2008-2009, and the market low was almost 6500, the 50% mark between those 2 values is 10,356. If the DOW value remains above that value, it is a bull market indicator, and if the DOW falls below, a bear market indicator.
Earlier this month both the NASDAQ and the Russell 2000 (not associated with Richard Russell) moved above their 200-day moving averages, a very bullish technical indicator in money management. The Global Dow (GDOW) is also nearing its 200-day moving average, which paints a bright picture for global investing.
In his time, Charles Dow closely tracked industrial/manufacturing stock averages as well as transportation indexes. Remember his theory, that these averages must confirm one another. If profits of manufacturers were increasing, then transport related indexes should also increase since those goods being produced need to reach distribution channels and the end consumer. Russell points out in his latest letter that while the November low for transports was 4838, they are currently valued at 5310, 9.75% above last month’s low. This is absolutely a bullish economic indicator.
While the Dow Theory is interesting (and worth studying for nothing more than insightful knowledge on the markets), at the end of the day it is just that, a theory. We have a tendency to say that “theories work, until they don’t.” What is important is not so much the theory itself, but the subscription to the theory. Dow Theory is widely accepted and followed by many investors and money managers. For example, when Dow Transports broke their previous high of 5200, we saw a bump in the Dow Jones Industrial Average. When a majority of the market reacts to a certain theory, if we as investors can become well-versed in that theory we can more accurately predict trends in the markets.
Whether technically speaking or anecdotally speaking, we have been calling for a bull market rally in several sectors and in US equities overall for over a year now. We view pessimism in the markets at this point is misplaced and not substantiated by any solid evidence. If these technical indicators have anything to say about it, prepare for a great start to 2013 in the markets.