The Near Dormant Dow Theory?

By Kenneth Robson on July 18, 2012 • ( 0 )

The Wall Street Industrial Average remains arguably the most watched index today, despite the proliferation of market and sectoral indices around the world. Yet it monitors only the share price of 30 US stocks.

The present composition of the DJIA is as follows:

AA Alcoa

AXP American Express

BA Boeing company

BAC Bank of America

CAT Caterpillar inc

CSCO Cisco Systems

CVX Chevron Corp

DD Du Pont

DIS Walt Disney Company

GE General Electric Company

HD Home Depot

HPQ Hewlett Packard

IBM International Business Machines

INTC Intel Corporation

JNJ Johnson & Johnson

JPM JP Morgan Chase & company

KFT Kraft Foods

KO Coca Cola Company

MCD McDonalds Corp

MMM 3M Company

MRK Merck & Company

MSFT Microsoft Corp

PFX Pfizer Inc.

PG Proctor & Gamble

T AT & T Inc

TRV The Travellers Company Inc

UTV United Technologies Corp

VZ Verizon Communications Inc

WMT Wal-Mart Stores Inc

XOM Exxon Mobile Corp

Whilst officially this index was created in 1896 with just 12 leading Industrial stocks, Charles Dow used various averages before then, to study market fluctuations; indeed ever since becoming involved in financial journalism in 1877 for the Providence Journal. It was these studies that formed the basis for his observations of the three categories of share price movement, and the basis for technical analysis.

Bull and Bear markets were defined on the basis of the high and low points of stock averages. In a bull market, the average increased, whilst in a bear market, the average fell. For example

In 1877 there was a market crash which resulted in a fall of the average of 60 stocks from a high of 76.57 in September 1872 to a low of 36.33, and a decline of 40.24. But it was followed by a bull period from April 1877 to May 1881, an era of railway expansion that saw this average recover by 63.47 to 99.8. One group of stocks which out performed in this time were the Granger stocks.

i.e.

Certain railroads whose traffic largely consist in carrying the produce of farmers or grangers; – specifically applied to the Chicago & Alton; Chicago, Burlington & Quincey; Chicago, Rock Island & Pacific; Chicago, Milwaukee & St. Paul; and Chicago & Northwestern, railroads.

According to Dow’s calculation bull and bear primary trends lasted 4 year or more, and reactions from the primary trend afforded the most favourable opportunities for entry. Short term daily fluctuations he regarded as too erratic and brief for profit for all but short term traders.

Dow provided the rationale for still the most successful investment strategy, trend investment. For “long only” investment the objective was to hold quality stocks through the period of the bull market as defined by a study of the averages.

The decision to only diagnose the trend when both the Industrial average and the Railroad average confirmed each other was sensible since the Industrial Index reflected the health of the emerging manufacturing industry, whilst the Railroad index reflected the strength of the previously dominant agricultural economy.

We may think we now have more sophisticated investment tools, but it is hard to argue with the simplicity of investing in bull markets, and abstaining in bear markets. Not a formula for quick profits, but a rationale for sound investment returns.

Careful observers reflect the landscape of their day. The details will change, but the vision remains.

Indices are still a valuable guide to economic health, and a valid guide to investment timing for those who regard timing as important.