Dow Theory is an equity investment thesis introduced over a century ago by Charles H Dow, co-founder of the Wall Street Journal. He theorised that asset prices move in clearly defined cycles. And it was important for investors to understand what stage of the cycle the markets were in before executing buy or sell orders for stocks.
The video above explains the basics and also points out Dow Theory has its critics. Mostly because of changes in the economy. But the broad principles based on behaviour by market participants are still valid. Which gives us two points to consider in the context of your current investment strategy.
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First, in Dow Theory, markets move through distinct phases of 1) accumulation by insiders starting the upward trend; 2) participation by retail investors creating a speculative frenzy; 3) sales by insiders triggering the start of a selloff; 4) panic sales by the public that drops prices sharply; 5) a restarting of the cycle through accumulation of cheap stocks by insiders….
Secondly, Dow Theory’s turning points are always marked by high levels of volatility. Its followers could easily extrapolate that we’re near one of these cyclical turning points after last night’s sharp decline on the back of Wednesday’s price surge – both moves the largest in a single session for two years (see story below)
The conclusion? Professionals earn the big bucks by judging when to buy or sell shares. For the rest of us, stoicism over the long-term works best. The current volatility suggests we could be nearing the end of the selloff. Or maybe not. The most important reminder is that equity investors are rewarded for being calm during turbulence. Because this too shall pass.
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Dow, S&P 500 Slide More Than 3% as Investors Reassess Fed Comments
Technology-related shares drop sharply, pulling the Nasdaq down 5%
By Caitlin McCabe and Hardika Singh for The Wall Street Journal
The stock market took its biggest U-turn since the early days of the pandemic Thursday, with the Dow Jones Industrial Average posting its largest decline this year just 24 hours after its largest gain since 2020.
The reversal wiped out the euphoria that reigned on Wall Street Wednesday in the wake of Federal Reserve Chairman Jerome Powell’s comment that the Fed wasn’t “actively considering” raising interest rates by 0.75 percentage point at a future meeting. With inflation at its highest level since the early 1980s, markets had been anticipating such an increase and the prospect of a slower rise in rates set off a furious buying spree in the late afternoon.
The optimism behind that rally was long gone Thursday, when selling was widespread, though most intense for technology shares, which have fallen on hard times in 2022 after years of leading the market advance.
Tesla dropped 8.3%, and Amazon.com fell 7.6%. Bank stocks, a key indicator of economic expectations, dropped 2.7%, according to the KBW Nasdaq index of large commercial lenders. The Russell 2000 index of smaller U.S. companies fell 4%.
“The market yesterday was a relief rally,” said Seema Shah, chief strategist at Principal Global Investors. By Thursday, she said, the realities of a more challenging environment for stocks were starting to settle in, including higher rates, difficult earnings comparisons and a stronger U.S. dollar, which weighs on overseas earnings at multinational firms.
Thursday’s rout is the latest instance of the volatility that has characterized markets this year and highlights the unease over the likely impact of the Fed’s rate-increase campaign, which aims to reverse years of a relaxed policy.
That unease is amplifying the tendency of many investors to sell some shares into market rallies, in a bid to rebalance portfolios that might have become too concentrated in the shares of firms that benefited from pandemic-era stimulus.
The Nasdaq Composite Index fell 647.16 points, or 5%, to 12317.69, the largest one-day percentage decline since June 2020. The S&P dropped 153.30 points, or 3.6%, to 4146.87, and the Dow slid 1063.09 points, or 3.1%, to 32997.97, erasing Wednesday’s gains. The major indexes declined between 7.02 and 9.38 percentage points from Wednesday’s highs to Thursday’s lows, according to Dow Jones Market Data, their largest swings since the first half of 2020.
In the bond market, the yield on the benchmark 10-year Treasury note rose to 3.066%, the highest level since November 2018. Bond prices fall when yields rise.
The pullback came a day after major U.S. stock indexes soared, with the Dow climbing more than 900 points, its biggest one-day gain since 2020. On Wednesday, central-bank officials approved a half-percentage-point interest-rate increase, lifting the federal-funds rate to a target range between 0.75% and 1%.
“The Fed is reducing liquidity in the markets, and that’s driving up volatility, and so this could be our new normal here for a bit until the Fed gets inflation under control and changes the policy,” said John Ingram, chief investment officer and partner at Crestwood Advisors.
Even with a larger interest-rate increase off the table in the coming months, investors are still facing the most aggressive tightening of U.S. monetary policy since 2000—the last time the central bank last raised rates by a half-point. Though many investors say the market setup then was drastically different from the one now—with valuations then higher and many of the highest-flying dot-com firms lacking long-term business prospects—it isn’t lost on them that that year ended with signifcant declines for the major indexes.
Many investors are now questioning how high the Fed might raise rates over the next two years in the midst of soaring inflation and questions on how that might ripple across the economy and corporate profits.
“It’s like when we all take medication, it’s got to build up in your system, and these fed-fund rises always have a lag time,” said Tim Horan, chief investment officer of fixed income at Chilton Trust.
On Thursday, those jitters were seen across the market. Growth stocks were particularly hard-hit. Chip makers Advanced Micro Devices, Nvidia and NXP Semiconductors all declined at least 4%. Megacap technology stocks also pulled back, with Meta Platforms falling 6.8%, Netflix declining 7.7% and Apple slipping 5.6%.
Higher interest rates can diminish the allure of technology stocks by reducing the value that investors place on their future earnings. Higher yields in general also boost the attractiveness of fixed-income products versus riskier assets such as stocks.
Some of the stocks that were darlings in the pandemic also lost ground. Etsy tumbled 17%, after the online marketplace released guidance below expectations for the current quarter. EBay lost 12% after cutting guidance on the impact from the war in Ukraine.
Shares of Wayfair slid, losing 26% after the online home goods retailer posted a bigger-than-expected quarterly loss. Shopify’s first-quarter earnings missed analysts’ expectations, sending the stock down 15%.
“We struggle to see who is going to be a massive buyer of equities in the next couple weeks,” said Viraj Patel, global macro strategist at Vanda Research. “It’s a waiting game for that catalyst…You need more conviction from the data, either to show that inflation has topped out or the economy is slowing and that the Fed won’t need to be as aggressive.”
Bucking the trend, shares of Twitter jumped 2.7% after Tesla Chief Executive Elon Musk said he has received letters from investors committing more than $7 billion in fresh financing to boost the equity part of his offer to buy the social-media company. Last month, Twitter agreed to a deal with Mr. Musk to take the company private for $54.20 a share.
Booking Holdings jumped 3.3% after its revenue exceeded expectations and it said it has seen a strengthening of global travel trends in the current quarter.
Assets that investors perceive as safer were among those to rally Thursday as money managers looked for havens as stocks and bonds fell in tandem. Even after Wednesday’s rally, some strategists and investors said they were hesitant about the stock market’s outlook in the weeks and months ahead.
“If they try to do too much and the market comes unglued, then they’ve kind of shot themselves in the foot because it will make it difficult to do future rate hikes,” said Jordan Kahn, chief investment officer at ACM Funds, referring to Fed policy makers. “That’s the fine line the Fed is trying to walk—to do as much [rate increases] as they think the market can digest without upsetting it too much.”
Mr. Kahn said his firm is holding higher cash balances than usual. Within the stock market, he is bullish on the energy and materials sectors, predicting that they will continue to benefit from supply-demand imbalances.
In oil markets, Brent crude, the international benchmark for oil, rose 0.7% to $110.90 a barrel. On Wednesday, Brent logged its largest one-day gain in more than three weeks after the European Union proposed a ban on imports of Russian crude within six months and on refined oil products from the country by the end of the year. The Organization of the Petroleum Exporting Countries and its allies, together called OPEC+, met Thursday to discuss production targets.
The WSJ Dollar Index, which measures the greenback against a basket of 16 other curriencies, rose 1.1%. On Wednesday, the index tumbled 0.9%, its largest decline since November 2020. The dollar’s status as the world’s reserve currency makes it a particularly attractive haven for investors.
Gold prices, another preferred haven, also climbed, rising 0.4% to $1,874 a troy ounce.
The British pound dropped about 2% against the dollar after the Bank of England raised interest rates but signaled that it is likely to move cautiously in coming months as worries grow over a slide into recession.
Overseas, the pan-continental Stoxx Europe 600 fell 0.7%. In Asia, Hong Kong’s Hang Seng fell 0.4%, and the Shanghai Composite rose 0.7%. Markets in Japan were closed for a holiday.
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