The Investment U E-Letter: Issue # 382
Friday, October 29, 2004

Richard Russell: His Dow Theory and a Warning About Stocks
By Steve Sjuggerud, President, Investment U

“I’ve never seen anything like it it’s the most flagrant divergence and series
of non-confirmations in the history of the U.S. stock market.” Richard Russell

Richard Russell looks at the stock market all day, every day – right now, he doesn’t like what he sees. Russell, who has been writing The Dow Theory Letters for 46 years, is well known for making great stock market calls like the one he made in 1974

In December of 1974, the Dow Industrial Average was down 35% for the year. Stocks had basically done nothing for 12 years. People had lost money in stocks for so long that they couldn’t stand the thought of buying them.

Wall Street was in despair. That’s when Richard Russell encouraged his subscribers to buy. Russell got it right. The Dow rallied 75% over the next 18 months.

So how did Richard Russell do it? Using The Oldest Stock Market Indicator Around

Richard Russell uses an indicator called Dow Theory to help him make market calls like his 1974 “call to buy.” We’ll look at Dow Theory today, and we’ll see why it says you should be very careful about buying stocks right now.

Charles Dow developed Dow Theory in the late 1800s in his publication, The Wall Street Journal. He wanted to find a way to predict the big trends in the stock market.

Dow developed two market indexes, the Dow Industrials and the Dow Rails (now Dow Transports). He figured if both industrial stocks (representing production) and transport stocks (representing distribution) were moving up, then the two indexes were in “agreement,” meaning the stock market and economy were in good shape.

Dow called this agreement between the two averages a “confirmation.”

Dow also considered the market to be ready for a sell-off when one of the indexes rose to a new high while the second index lagged behind. As Dow’s work became the basis for modern technical analysis, many of his students used his theory to make fortunes in the stock market.

What Dow Theory and Richard Russell Say Now

According to Richard Russell and his interpretation of Dow Theory, the industrial stocks and transportation stocks have been in “flagrant non-confirmation” mode for about eight months.

In other words, they’ve been heading in opposite directions. The Dow Transports are having a great year, up 14.2%. The Dow Industrials have been doing poorly, down 5.4% for the year.

Taking a look at the two charts it’s easy to see what Richard Russell is talking about. The chart below compares the 2004 performance of the Dow Industrials, down 5.4% for the year, versus the Dow Transports, up 14.2% for the year:

Russell also points out that the essence of Dow Theory is values. Charles Dow advocated buying stocks when you can get a great deal for your money, when stocks are cheap. For example, Dow liked to buy stocks when the overall market had a Price-to-Earnings ratio of 8.

Dow Theory: Buy When They’re Cheap, Sell When They’re Expensive

Dow also advocated selling stocks when they got expensive. With a current Price-to-Earnings ratio of 19.5 (as measured by the S&P 500), the general market is considered expensive. Dow would be selling today not buying.

The non-confirmation of the two averages and the expensive market are making Richard Russell cautious right now. He wants his subscribers to keep their stock market exposure light and keep plenty of their assets in cash and gold.

Just like any other stock market tool, Dow Theory shouldn’t be used alone to help you make your investment decisions – but history has proved it’s a valuable guide to size up the big picture.

Right now, Dow Theory says “be careful.” Wall Street legends like Richard Russell are heeding its warning. You should too. Here’s an archived issue featuring more from Richard Russell. In “A Simple and Powerful Investment Concept,” we’re reminded of the value of avoiding investments that contain more risk than potential return.

Today’s IU Cribsheet

• For more on Dow Theory, visit http://www.dowtheoryletters.com and click on the link on the bottom left called “The History of Dow Theory.” You can read more about Richard Russell and his take on our oldest market indicators.
• I’d also like to tell you about the Oxford Club Argentina Tour with Alexander Green, January 15-22, 2005 (with special guests Horacio Marquez and Michael Checkan). Not only will you stay in the country’s finest hotels and dine in the most exclusive restaurants, you’ll also be guided and escorted at all times by the top businessmen in the country. You’ll be welcomed in private homes You’ll tour giant ranch estates And you’ll be shown the best of what the country has to offer, from the vantage point of an investor (There’s also an optional extended trip to Punta Del Este, Uruguay, through January 26.) For more information on joining this tour, please contact Agora Travel at 800.926.6575 or 561.243.2572.

Good investing,

Steve

P.S. More Investment U articles featuring Richard Russell can be found below:

• Investment Concepts: Simple and Powerful
• Investing in a Bear Market
• Investor Sentiment Indicators

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