|RICHARD RUSSELL THE CONTRARIAN|
MONDAY, MARCH 22, 2004
Dow Theorist Richard Russell sees bear tracks on the beach
By JENNIFER ABLAN
MORE THAN EVER, RICHARD RUSSELL feels like a loner these days. Here's the U.S. economy, poised to expand in 2004 at the fastest rate in 20 years. There's the Dow Jones Industrial Average, rising 24% in the past 12 months, and the Nasdaq Composite, soaring 41% in the same span. Everywhere, it seems, the animal spirits are returning.
But the only animal Russell sees is a big, ugly bear. "I'm afraid we are coming into one of the worst bear markets in history," he says.
At 79, Russell has decades of experience running against the tide. As founder and scribe of the Dow Theory Letters (and a sometime contributor to Barron's), he practically has made a career of bucking Wall Street's conventional wisdom, much to his fans' delight.
When, in his December 1974 investment newsletter, Russell declared an end to the brutal bear market that had begun in January 1973, many wrote off the man and his theory. Of course, the Dow, then trading at 577, took off on a 27-year tear -- the greatest bull market in U.S. history -- and never looked back until hitting 11,722 in the spring of 2000. Not coincidentally, that was just about the point at which Russell presciently called the top.
Richard Russell launched Dow Theory Letters in 1958, and has earned a reputation as a savvy contrarian. He sees the U.S. heading into a depression.
Strictly speaking, Dow Theory wasn't invented by Russell, but arguably he has done more than anyone to popularize the analytic system developed in the late 1890s by Charles Dow (founder of the Wall Street Journal, which, like Barron's, is published by Dow Jones). Dow Theory aims to identify the primary trend in the stock market, lasting from one to several years, and stipulates that the Dow Jones Transportation Average must "confirm" a high or low in the Dow Industrials for a bullish or bearish trend to stay in place.
The theory is based on the premise that the Transports, originally called the "rails index," haul what the Industrials make. If the goods aren't heading to market, the economy -- and stock market -- are heading south.
Gaze upon the chart below, and you will understand Russell's concern: a "chronic divergence" in the Dow Theory's twin pillars. On Feb. 11, the Industrials hit an interim peak of 10,737.70. But the Transports, which broke down in late January, have yet to confirm this high, which called the top, he says, for "this upward correction in a continuing bear market."
In part, transportation stocks have been set back by the recent rise in crude-oil prices. Oil futures are trading at more than $38 a barrel for the first time since the eve of Gulf War I in 1990.
Many market seers today dismiss Dow Theory as an outmoded analytic tool. In a world where the information superhighway has superceded the freeway, they attach little importance to an index of 20 airline, air-freight, railroad, trucking and marine-shipping stocks. Even the Standard & Poor's 500 stock index has given short shrift to such Old Economy movers, few of which are represented in its vaunted ranks. Russell counters that the Transports still play a vital role, and that companies such as AMR's American Airlines unit, United Parcel Service, FedEx and CSX "pretty much are an indicator of sales, shipping and travel activity."
More important, Dow Theory has proved successful in calling major tops and bottoms -- and October 2002, in Russell's view, definitely wasn't a bottom. "It was a halt or temporary stop in a long-term bear market," he says.
Nonetheless, at that point Russell told subscribers to buy two popular exchange-traded funds -- SPDRs, based on the S&P 500, and Diamonds, which track the Industrial Average. It was another wise call.
Russell's interest in Wall Street dates to 1946 when, fresh from the Army Air Force, he read a piece in Time Magazine about the glorious future of Kaiser-Frasier cars. With money he inherited from his uncle, who committed suicide by jumping out of a Manhattan hotel window after the 1929 Crash, Russell bought a few shares of Kaiser in the 20s.
They promptly fell to 10.
Possessed of a sunnier temperament than his benefactor, Russell set out to learn how a sure thing could turn out so badly. In the mid-'40s, he says, there was little information to help people understand the stock market. But when he came upon a collection of articles by Robert Rhea who, from 1932 until his death in 1939, penned a newsletter called Dow Theory Comment, he was hooked.
Russell launched his own Dow Theory Letters in 1958, and more recently added a Website, www.dowtheoryletters.com. A native New Yorker, he has been based in La Jolla, Calif., for 37 years. Although the publication has only 7,000 subscribers, Russell and his work are well known among market technicians.
If Dow Theory is the linchpin for his calls, Russell also pays heed to other factors in forming his market view. Price-earnings multiples are key. At 2002's lows, for instance, the S&P was selling for slightly more than 30 times trailing earnings, and yielding 1.9%. Valuations "were ridiculously high," he says.
Bear markets typically end with the Dow Jones Industrials and S&P 500 selling for five to 10 times earnings, while yielding 5% to 6%. Russell doesn't expect this beast to be much different. "Let's say this bear market ends at eight times S&P earnings," he says. "Even if earnings hold at the current level -- which is extremely doubtful -- the S&P could lose two-thirds of its value."
Earnings are expected to rise sharply this year (see p. 23). "But the stock market is a discounting mechanism, and all estimates of future earnings are simply guesses -- and very often wrong guesses," Russell says.
Nor does the Federal Reserve's behavior in recent years suggest a market bottom. The Fed has lowered short-term interest rates 13 times since January 2001, to a targeted 1%. But Fed chief Alan Greenspan "is still fighting the bear, tooth and nail," Russell says.
Russell expects foreigners' faith in the dollar to continue to erode, and predicts the U.S. currency could lose about half its current value. America's growing fiscal and external deficits, as well as record consumer debt, are " a short sale against the dollar," he says.
In Russell's view, the economy still is paying the price for the excesses of the late 1990s. Worse, the Fed's serial easing has created even more excesses, particularly in housing. Sooner or later the bubbles will burst, he warns, thrusting the U.S. economy into depression.
In the meantime, Russell advises subscribers to hold cash and gold, which, at $400 an ounce, is "as cheap as dirt." Eventually, he sees the yellow metal topping $1,000 an ounce -- and the Industrials and Transports plummeting. For this Dow Theorist, it's the perfect set-up -- for the next bull market.