The 'Sage of the Dow' is Also Confused

|
 |  Includes: DIA, SPY
by: Babak

Far be it from me to criticize a luminary of technical analysis but it certainly appears that Richard Russell is confused.

For those who are unfamiliar with him, Richard Russell is known as the Sage of the Dow for his expertise in Dow Theory. He has been writing about the market non-stop for more than 50 years and has made some truly legendary calls.

In the past few years Russell was very bearish and recommended gold instead of equities. This changed in May 2007 when he surprised everyone by turning into a bull, saying, “an unprecedented world boom lies ahead”.

But recently Russell has changed his mind again, saying, “the long-term trendline has been violated… Until proven otherwise, the long-term trend of the Dow is now down.”

He was referring to the red support line in the chart below:

dow jones long term chart richard russellClick to enlarge

Russell drew the trend line from the low in 1982, the launchpad of the great bull market in modern history, to the low of the bear market in October 2002. Clearly, this support is now violated to the downside.

This sounds very logical but if you stay with me for a bit, I’ll explain why I have a tough time accepting it.

Let’s imagine that we have gone back in time to the desolate bear market of 2002. Prices are careening into an abyss, pessimism is so thick you can cut it with a broker’s statement.

Now, standing as we are back in 2002, we follow the same process that Russell did and draw a trend line showing the support level in the Dow Jones from the bottom of 1982, connecting it to the low in 1995 and the low created in the aftermath of the September 11th 2001 tragedy. The line would look something like the dashed purple one in the chart above.

Obviously, even if we imagine ourselves in October 2002, for the sake of this exercise, we had no way to know for sure that this was the bottom. So rather than use it as the point through which to draw the trend line, we would use the points mentioned above.

So the conclusion that we would then draw is that the long term chart of the market is broken and the trend of the Dow is down.

But that would be incorrect.

Because not only would the worst of the bear market already have been over, within a very short time a new bull market would be born.

So clearly, hunkering down into “bear market mode” at this point in time (mid to late 2002) would do us no good at all. In fact, the smartest thing would be the opposite, to have cast around for beaten down stocks to buy in anticipation of the termination of the brutal bear market that we had so far endured.

Richard Russell usually concentrates on the Dow Jones but here is the chart of the S&P 500 for good measure, showing the same thing:

spx long term chart richard russellClick to enlarge

In the end, I’m afraid this leaves us where we started: confused. But it is one thing to flop around randomly, switching sides as the wind blows, and quite another to confess in frank humility before the power of the market that one is confused.