Dow Theory: Secular and Cyclical Markets

We often mention the concept of secular and cyclical markets in our discussion of Dow Theory.  So far, we believe that we’re in a secular bear market owing to the fact that the Dow Jones Industrial Average and Dow Jones Transportation Average cannot meaningfully exceed prior peaks.  However, we feel it is necessary to provide a graphical representation of what a secular and cyclical market looks like.

Keep in mind that active analysis of Dow Theory provides cyclical indications of moves in the market which usually lasts from 2 to 6 years.  Depending on the circumstance, which usually hinges on the quality of analysis, Dow Theory also provides an indication of secular trend changes in the market.  However, secular trends usually encompass periods from 16 years to as many as 24 years.

In this assessment, we’re assuming that Dow Theory was only able to provide bullish signals at 1/4  of the move from the bottom and bearish signals 1/4 of the move from the top for each cyclical trend.  This is a very generous assumption in favor of those who are critical of the validity of Dow Theory as a market forecasting tool.

Historical Perspective and Highlights

First, let us start with the history of stock market secular trends from 1906 to the present broken into the various cyclical moves that can be easily identified (detailed review of stock market from 1860-1906 found here).  The first secular trend is from 1906 to 1924 in what is clearly a bear market.  Our definition of a secular bear market is the inability of the Dow Jones Industrial Average to exceed a prior high level for an extended period of time.  As seen in the chart below, the 1906 to 1924 period certainly fits the bill.


The secular bear market from 1906 to 1924 was 18 years long.  As indicated with the arrows (green arrows for cyclical bull markets and red arrows for cyclical bear markets) there were many instances where an investor could have avoided the losses of buy-and-hold if Dow Theory was applied.

What should follow a secular bear market is a secular bull market, however, the period from 1924 to 1942 was a combination of both with a quasi-secular bull market from 1924-1929 and a quasi-secular bear market from 1929-1932.  Charles H. Dow has commented that markets move like a pendulum, swinging from excessive gains to excessive losses. S.A. Nelson has specifically outlined Dow’s point by referring to the extremes of these swings in the market as “artificial advances” and “artificial depressions.” (found here).  William Peter Hamilton’s account of Dow Theory on November 17, 1924 was as follows:

“At the opening of the week the industrial and railroad share averages simultaneously broke through all previous points of resistance this year so decisively as to constitute by the Dow theory of analysis as emphatic and indication of a major bull market as has ever been discovered in the long history of the movements of these averages.  By the end of the week the industrials were up approximately three points and the railroads two points through their previous best prices this year.  That spells a dynamic movement of impressive proportions and unquestionably it forecasts in due time a further sustained upward movement that will eventually better every price yet seen.” (source: Hamilton, William Peter.  “What of the Market?. Barron’s. November 17, 1924. page 2.)

The compressed period of time that the Dow Industrial Average rose from 100 to 381 might have been the first clue that the gains were not sustainable.  As an example, in the secular bull market from 1942 to 1966, it took 12 years to rise an equal percentage amount.  Likewise, in the secular bull market from 1982, it took the Dow Industrials 13 years to equal the percentage gains made from 1924 to 1929. Fortunately for some and unfortunately for many, the 1924-1942 period provided both secular moves within a single secular timeframe.


Shortly before his passing, William Peter Hamilton, Dow Theorist and fourth editor of the Wall Street Journal, wrote his famous “Turn of the Tide” editorial in the Wall Street Journal and Barron’s indicating that the bull market move had ended when the Dow Industrials were trading at around 325.17 (source: “A Turn in the Tide”. Barron’s. October 28, 1929. page 14).  The follow-up analysis of a new bull market came from Dow Theorist Charles J. Collins who suggested that “…failure on the part of the rail average to confirm the weakness in the industrial list suggested a rather strong foundation to the market (source: Collins, Charles. Barron’s. August 8, 1932. page 5)”.  At that time, the Industrials were trading at the 67.71 level.  The subsequent move in the Dow Industrials to the March 1937 high was over +180%.  Likewise, the decline that followed to the 1942 low was equal to -48%.

With the stock market reeling from the “adjustment” from the 1929 peak and crash, the next move in the market should have been a secular bull market.  The next move in the market was, in fact, a secular bull market that ran from 1942 to 1966.  The ideal for any market forecaster is to be able to distinguish a secular bull market from a cyclical bull market within a secular bull trend.  The reason for this is because, if correct, investors can stay fully invested through the entire secular bull trend while taking advantage of short-term declines with new investment of funds.  Cyclical bull markets within a secular bear trend require investors to sell some or all of their stock to be repurchased at the next Dow Theory cyclical bull market indication.


The secular bull market move from 100 to 1,000 was every investor’s dream.  However, the stock market collapse and the “Great” Depression that preceded it kept the majority of investors out of the market until the final run-up from 1962 to 1966.  Naturally, just as the majority of investors became confident of the secular bull market, the secular bull market was on its last leg.  Richard Russell had the following to say of the 1966 Dow Theory bear market signal:

“Having failed to hit new highs on the April [1966] recovery, the two Averages again retreated.  On May 5 the March lows were penetrated to the accompaniment of heavy volume.  Based on the method formulated by Charles H. Dow at the turn of the century, the two Averages on May 5 gave the signal for a primary bear market.  We now know that the February-March [1966]decline was the first leg of the bear market, and the March-April [1966] rise was the first (upward) correction.  the second leg began in late April and remains in force (source: Russell, Richard. “Bear Market Signaled Under Dow Theory”. Barron’s. May 9, 1966. page 31.)

The secular bear market that followed from 1966 to 1982 seemed brutal on a relative basis.  However, it was no worse or better than the secular bear market from 1906 to 1924.  Much of the reason that the period from ‘66-‘82 seemed particularly difficult is mainly due to how recent it occurred rather than the relative depth in the market decline.  It lasted from 1966 to 1982 or 16 years.


The secular bear market from 1966 to 1982 experienced five cyclical bear markets and four cyclical bull markets.  For all intents and purposes, it was among the worst times to be a buy-and-hold investor.  However, our favorite article in review of this period is Jeremy Siegel’s  “Nifty Fifty Revisited” which showed what would happen if an investor had bought and held the hottest stocks from the peak in the market in 1972 (those stocks with the highest P/E ratios) and reviewed their performance until 1995 (PDF found here).  There is merit in buy-and-hold investing and for our money the Siegel article makes the case quite well, especially if the investor happens start investing in a secular bear market and has an investment horizon with a minimum of 20 years.

The secular bull market that followed the secular bear market of 1966 to 1982 lasted from 1982 to 2000 and saw the Dow Jones Industrial Average rise from 1,000 to approximately 11,500.  Although we’ve indicated that the year 2000 was the end to the secular bull market, a valid case can be made for 2007 as the end of the secular bull market.  In either case, the Dow Industrial Average is marginally above the 2000 level or below the 2007 peak.


Our interpretation that we’ve been in a secular bear market since 2000 or 2007 only holds water as long as 11,500/14,164 is the range that the Dow Jones Industrials trades in.  A common timeframe for our version of secular periods averages around 18.8 years based on the previous five periods.  This suggests that if the 2000 peak holds then the secular bear market should end in the years between 2016 to 2023.  We’re partial to the idea that the 2007 top was a secular peak.  Richard Russell had the following to say on the topic of Dow Theory shortly after the 2007 peak:

“Did last week’s market volatility make you queasy? If you believe in the Dow Theory, there was reason to be wary.  The Dow Jones Industrial and Transportation averages plunged to end-of-day lows of 12,845.78 and 4,672.35, respectively, on Aug. 16. Both then rallied. But while the industrials hit a record 14,164.53 on Oct. 9, the transports didn't come near a record, thus failing to confirm the DJIA's strength. This set up the potential for a classic Dow Theory bear-market signal” (Russell, Richard. “What Does Dow Theory Says”.  Barron’s. November 12, 2007. link here.).


Summary on Secular and Cyclical Trends

Classic secular bull market moves typically require investors to only buy in the beginning and hold ‘til the end.  The obvious challenge is to understand and accept that the prior secular bear market should be followed by a secular bull market.  This is a difficult psychological transition for investors after experiencing four or five cyclical bear market moves over the course of 16 to 18 years.

Classic secular bear markets require timing tools like Dow Theory to keep an investor’s expectation in check with the investing environment.  Alternatively, investors who expect to buy-and-hold during a secular bear market must have a time horizon that is exceptionally long in duration and hold stocks that provide income to offset inflation and possible lack of capital appreciation.  Jeremy Siegel’s article titled the “Nifty-Fifty Revisited” is an exceptional rationale to hold stocks through a secular bear market (PDF found here).

Although Dow Theory can inform an investor of being in a secular bull and bear market after the fact, it is of greatest use at calling cyclical bull and bear markets, especially within a secular bear market. So far, we happen to be in the most ideal period when Dow Theory could be of the most benefit to investors.

more: The Stock Market from 1860 to 1906

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