Read it with care. What Schaefer writes here is not only an incredible historical document, but it is the very essence of Dow Theory.
Those who bought stocks here, and I was one of them, were buying stocks at the very beginning of one of the greatest bull markets in Wall Street history.
“THE DOW THEORY TRADER”
E. George Schaefer
NO TRADER CAN AFFORD TO IGNORE THE DOW THEORY
Saturday, June 18, 1949
MARKET PSYCHOLOGY － When the consensus of opinion among the ‘crowd’ has reached the point where it confidently expects the stock market to decline; market psychology suggests that the bottom of the bear market may not be far away. On Monday and Tuesday of the past week a most bearish market psychology prevailed among the trading public as the low closes of the past 2½ year’s trading range was violated. Short selling became quite popular as those positions were precariously extended on the occasion. A rapid deterioration of any remaining bullish confidence was evident as the bears exuberantly predicted considerably lower prices for the market place. Statements such as, ‘You haven’t seen anything yet’, and ‘You will be able to buy them at half the price’ were frequently heard in brokerage rooms. These are manifestations representing the most depressed psychology of a bear market. The lowest ebb of investment confidence among the public is always apparent at the lowest points in bear markets.
When the trading public becomes certain that the stock market will decline, astute traders and investors will regard this as a bullish symptom for the future trend of stocks. Exactly the reverse was true one year ago, when the cycle reached its opposite extreme and a feeling of certainty existed that the market would continue to advance. Market history is filled with instances where the ‘crowd’ became bearish at the bottom and bullish on top. The present case is, we believe, no exception. The bear market has reached a stage where an overwhelmingly bearish psychological condition is at hand. Based on precedent, the present situation warrants close observance for a turning point in the market.
The intensity of the situation is reflected in the over-crowded short interest that present-day short sellers are confidently ignoring. When the latest short interest total is published within the next few days, it will probably represent the largest since 1932, when one of the worst depressions in the nation’s history was at hand. An abnormally large short interest has always served to electrify swift and large advances in the stock market, and the present case will be no exception. The longer the downtrend persists with an increase in total short positions, the more sensational will be the advance when it finally materializes.
BULLISH FACTORS ─ During the past three years, market swings have been relatively narrow, and, under the Dow Theory, three changes in primary trend have occurred. A bear primary trend was in effect from May-June, 1946, to May, 1947. A bull classification was given the primary trend from May, 1947, to June-July, 1948. At the present time, another primary bear trend has been under way since the highs of June-July, 1948. Each of the first two primary trends were of approximately one year’s duration, and the present primary bear trend is again at the one-year mark. If the current bear market is to correct only those excesses which occurred in the preceding bull market, a sufficient correction in both time and extent have already been made. This factor favors another change from bear to bull in the primary trend in the near future.
Up to this writing, the market has not penetrated the intra-day lows of its 2¥-year trading range. Until a decisive breakout of this area occurs, the averages could advance and test the upper limits of the area, or continue to fluctuate within that range for an extended period of time. The industrial average established an intra-day low of 160.49 in October, 1946, and the rail average recorded its extreme intra-day low of 40.43 in May, 1947. These lows were closely approached by both averages during the past week, but were not violated. On Tuesday, the extreme intra-day lows of the current bear market were recorded at 160.62 and 40.88. A slight decrease in volume was noted at the lows, while odd-lot short sale orders skyrocketed to 121 on the very low day. The fact that the market refused to give a decisive downside penetration of its long 2¥-year trading area implies that a rally from those lows will develop after a sufficient test of those lows has been made.
Another bullish tinge was given the market by the appearance of a ‘gap’ of .24 in the industrial average on the downside on Monday. The possibility appears that this might have been an ‘exhaustion gap’, indicating that the market is becoming exhausted on the downside from its prolonged decline since March 30. More often than not, a gap occurring after a long decline signifies the end of that decline is near, and that an advance in the averages will follow.
An increasingly bullish factor in recent statistics has been the trend toward higher yields. At the intra-day lows of the past week, the 30 Dow-Jones industrials showed an average yield of 6.91%, while the 20 Dow-Jones rail stocks showed 9.12%. These high yields are approaching the extreme highs in yields recorded on only three other occasions during the past 17 years. The bear market lows of 1932, 1938, and 1942 were accompanied by peak yields in the Dow-Jones industrials of 10.38%, 8.07%, and 7.97%, respectively. A declining tendency in these peaks is noted, and, therefore, the current 6.91% peak may be in close proximity to the peak to be established in this bear market. A declining tendency has also been in effect for yields at the top of bull markets. In the bull markets which culminated in 1937, 1938, and 1946, the Dow-Jones industrials yielded 3.70%, 3.44%, and 3.23%, respectively.
CONCLUSIONS － The philosophy of Charles H. Dow always gave first consideration to values, then to economic conditions, and third, to the action of both the industrial and rail averages. When the low point of a bear market is being approached, values will give us the first indication of a change in trend. In the past 17 years only three opportunities presented themselves to buy stocks at great values, and now the fourth opportunity is making its appearance. We continue to regard stocks as having entered a ‘buying area’ on a basis of values. Good dividend paying issues should be purchased during periods of market weakness, and held until such time as yields for the industrial average are back into the 3% to 3½ % area. Once stocks are purchased, both the minor and secondary movements in the market should be completely disregarded. A new period of prosperity will follow, once the present recession has run its full course. From present indications, the current business recession will continue until later this year and possibly into 1950. Following that a two-to-five year period of prosperity will be sparked by a good foreign trade situation and by strong activity in the building and automotive industries. Television and other new industries will continue to flourish, and confidence will be placed in the stock market as it climbs back to a point where yields are close to the 3% point again. Based on present prices, earnings, and yields in the senior average, computations indicate that the eventual highs of the next bull market will be recorded in the 325 to 375 area.