Monday, May 14, 2007

Stocks and the Bull Market

The 50% Principle states that following an extended rise in the Dow, if a following decline retains at least half of the Dow's preceding gains, the primary trend is taken to remain bullish. I want to emphasize that the advance must be extended in both duration and extent. The 50% Principle cannot be applied to advances of a few months or so.

All right, now let's look at the market picture. The Dow had advanced from 759 at its 1980 lows to 11722 at its 2000 high. That was a bull market rise of 10963 Dow points. Half of that is 5481, so adding 5481 to the 759 low gives us a halfway or 50% level of 6240. Again, remember that the 50% Principle states that as long as the Dow remains ABOVE the halfway level of its preceding extended rise, the primary trend remains bullish.

The Dow started down from its January 2000 high and continued down to a low in October 2002. At its October 9, 2002 low, the Dow closed at 7286.27 -- this was far above the 50% level of 6240. Thus, under the 50% Principle, the primary trend of the market remained bullish.

Further proof that the 2000-2002 decline was a reaction in a continuing bull market rather than a bear market decline was seen via a test of values. I went back in my archives (you can do this too) and noted that at the October 2002 low, the yield on the widely-followed S&P Composite was a micro 1.79%, while at the same time the S&P was selling at 33.07 times earnings. The Dow was priced slightly better, but on either count, stock values were nothing like what one might expect at a true bear market bottom.

Thus, based on both the 50% Principle and on values, the "collapse" of 2000 to 2002 was a bull market correction, not a bear market decline.

I think what threw me off more than anything else was the astounding decline in the NASDAQ, which lost 78% of its total value. The NASDAQ collapse was comparable to the 1929-1932 decline in the Dow, at which time the Dow lost an incredible 89% of its total value. On top of that the S&P during the 2000-2002 lost almost half its value.

During 2000-2002 the whole nation was keyed in on the NASDAQ and the tech stocks. The disastrous smash of the NASDAQ helped to convince me that the primary trend had turned down. Sure, the bear market almost destroyed the NASDAQ, but it was the action of the Dow that I should have trusted. The 30 Dow stocks represent the "backbone" of US economy. The NASDAQ was, to a large extent, made up of wildly speculative tech stocks, few of which paid any dividends at all. As a matter of fact, this is still the case. The NASDAQ does not represent the US economy -- the Dow does.

So the lesson is this -- for the direction of the great primary trend of the market and the economy, use the D-J Industrial Average for your guide. Use the 50% Principle together with your study of values. At the 2002 lows, the 50% Principle applied to the Dow told us that the great primary trend of the market remained bullish. At the 2002 lows, values told us that this was NOT a bear market bottom -- quite the opposite, stocks at the 2002 lows were still overvalued and characteristic of an ongoing bull market.

Happily or maybe luckily, I zeroed in on the utilities following the 2002 lows. At the 2002 lows, many or even most of the utility stocks were providing "juicy" dividend yields of 6% or more. Since I always emphasize dividends I repeatedly advised buying the utility stocks. At the October 9, 2002 low, the D-J Utility Average stood at 167.57. The D-J Utility Average closed last Friday at 526.54. That means that the utility advance from the 2002 lows amounted to a rise of 215 percent.

Compare that to the Dow which rose from its 2002 low of 7286 to last Friday's close of Dow 13326. Thus, the Dow from its 2002 low has risen 82.9 percent, far less than the rise in the "conservative" Utility Average. Subscribers who bought the Utility stocks have done better, percentage-wise, than those who bought the Dow stocks. From: **DowTheoySubscription**


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