Rambus is out of town today and he asked me to pinch hit tonight. This will be a big picture, stream-of-consciousness perspective of what’s going on in the market. By no means will I have it all right, but I am applying the market principles I have accumulated over a life time in order build a model of where the market is.
Dow Theory
Yes, that’s right that long forgotten and abandoned system of determining the cycles of markets may not be dead after all. Actually the tenants of Dow Theory remain as valid today as ever. They are ignored, but they are still working in the background.
So let’s take a look at what Dow Theory is saying. Here is a view of the Dow vs the Transports for the duration of this bull market:
Above we see the first set of non-confirming highs in the DOW and Transports with the trannies being the weakest. The Dow double topped almost exactly in Dec/Jan. Close enough to consider the 31Jan 2025 top as the final top. However the Transports topped back in late November. That’s a two month non-confirmation top between the Dow and the Transports, a very classic bull market top sequence. It is typical for the transports to top first since they are more economically sensitive than the industrials. Next came the first reaction low and bounce off those lows depicted by the 2 blue lines. The Dow Theory sell signal occurred when both of these lows were violated shown by the red circles. Furthermore, the industrials violated its reaction low in no uncertain terms. That dual violation signaled the bear market has begun. We now go back and date the beginning of the bear market as 31 Jan 2025.
That’s what we know so far. Now we can build upon these principles with the purpose to build a model looking ahead. It is interesting that I have not heard anyone mention about these triggering events. Instead one simply hears mindless descriptions such as “the market entered into correction territory today”, or “bear market ground was reached after a 20% decline” These descriptions are worthless and have no meaning. Case in point, the huge wipe out in 1987 was not declared a bear market by Dow Theory. Why? Because Dow Theory sell signals are only valid when they are triggered in the third and last phase of an extended bull market. The 1987 market was in Phase II which is why once the crash was over it recovered.
When a bear signal is given in the third phase of a bull market the back of a bull market is broken, regardless if the economy seems to be in good order. The previous bull market plants the seeds of its own destruction in speculation and inflationary excess. It is now the bear’s turn to reconcile these imbalances.
Bear Market Phases
This would be a good time to review the three phases of a bear market.
Phase I – A phase I occurs when the crowd is rampantly bullish and hardly ready to believe the ominous signal. Informed operators finish up their campaigns of stock distribution to the general public (think NVDA). In this phase there is an abandonment of the hopes upon which stocks were purchased at inflated prices. They then begin selling those stocks minus the hopes and expectations of the previous bull market.
Phase II – The second and longest phase represents the reflection of worsening business conditions and decreasing corporate profits. This phase is typically strewn with severe panics and support lines are swept away along with shocked investors holding onto desperate positions, clinging to hope. News becomes disheartening, dividends are cut. Blue chips which had so far held up, suddenly collapse in a sickening fashion.
Phase III – In the last phase sound securities sell at distress or liquidation prices, regardless of their earnings or values. “It is in this third phase people sell their good stocks, held against a rainy day, because it’s raining”, observed Robert Rhea. An overall hopelessness prevails, many believe the country will not survive.
Often in Phase III the bottom comes after an annihilation drive. This is a relentless power dive of selling until finally it reaches a point where stocks become immune to the most shocking of news. Volume dries up and the bottom is in. This was the classic March-July 1932 45% decline which ended the worst bear market in US history.
The Lesson
Here is one of the chief lessons of Robert Rhea’s teachings on Dow Theory: “A primary bear market is caused by various economic ills and does not terminate until stock prices have throughly discounted the worst that is apt to occur.
Let’s make this very clear. This is saying that this very early stage bear market has a long way to go. Once a valid sell signal occurs, which it now has, the bear market goes to completion. That is, it transits all three phases. What this means for informed investors is it’s time for everyone to “get out of the water”. It is time to seek safety and protect yourself. No one knows how deep this bear market could go. If history serves as a guide we are looking at 18-24 months and down 45-55%. Last time we saw this in 2002 and 2009 baby boomers were able to recover. This time they won’t which could make it even a bigger liquidation event.
The Good News
The good news is that that there is always a bull market somewhere. This year 2025 is the year of the capital rotation event. That is the swap out of money flows away from financial assets into tangible assets and commodities. Once these events occur they typically remain intact for 10-30 years. That’s how we are going to make our money, shall I dare to say our fortunes. We can understand this process and how it will unfold.
Post Bubble Contraction Gold Bull Market
Here is something I have salivated over for 25 years now, but hasn’t happened yet. Last time we had one of these was in the early to mid 1930’s. It is the ultimate bull market in gold stocks. The legionary 1970’s weren’t even a PBC as amazing as those years were.
Due to time constraints I can’t develop this thesis tonight, but it would be a great follow on piece because it would describe the three phases of a bull market. Rambus willing.