Timing the Markets: Dow Theory for the 21st Century

The research report linked below is authored by Rory Gillen, founder of GillenMarkets, an investment advisory firm based in Dublin, Ireland.

Stock markets (equities) in democratic and pro-business economies have produced the best returns for investors over the long-term, in the main because industry generates better returns on the capital invested than one can obtain from bank deposits, government bonds or, indeed, gold. So long as one avoids overpaying for assets in the stock markets, an investor that saves and invests through them can reasonably expect to benefit from these superior returns less any costs. That said, stock markets can get overvalued and are regularly negatively impacted by adverse political and economic developments, which can lead to setbacks, and at times significant and prolonged setbacks.

An investor who is investing regularly – for example, with his/her pension monies – gets to invest in rising markets and declining markets. The regular investor carries much less risk as he/she naturally smooths out the inevitable ups and downs in markets and most likely, over the medium- to longterm, gets the average returns that markets generate.

It’s trickier for the lump-sum investor; the investor that (i) needs to protect his/her capital in the short-term or (ii) is unlikely to be in a position to add meaningfully to his/her existing capital and can’t, therefore, benefit from the better values that appear in weaker market conditions. The lumpsum investor has higher risk of investing when markets offer poor value, which normally leads to lower subsequent returns or outright negative returns over shorter timelines.

The lump-sum investor who wishes to participate in the superior returns that the stock markets offer but who also wishes to avoid deep setbacks can choose to try and time his/her entry into and exit from the stock markets (market timing). It’s easier said than done and must be recognised more as speculation than pure investment, but it offers choice and each to his own.

Dow Theory is a 120-year old method of timing the US equity markets first introduced by Charles Dow in 1900, the then editor of the Wall Street Journal. In his 2008 book Dow Theory for the 21st Century, author Jack Schannep brought this theory up to date for developments in markets since.

In this note, we explain Dow’s theory, and Jack Schannep’s version of it, and outline the returns of having followed this approach from 1954 to 2020 inclusive and compare them to:

• The returns that accrued to a ‘Buy & Hold’ investor in the S&P 500 Index over that period.
• The returns from hedge and absolute return funds since industry returns were formally recorded from 1998 to 2020 inclusive.
• The returns from a traditional multi-asset portfolio also from 1998 to 2020 inclusive.

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This publication has been provided by ILTB Ltd (t/a GillenMarkets). The information has been taken from sources we believe to be reliable. We do not guarantee their accuracy or completeness and any such information may be incomplete or condensed. All opinions and estimates constitute best judgement at the time of publication and are subject to change without notice. The information and material presented in this document are provided for information purposes only. This document is not to be relied upon in substitution for the exercise of independent judgement. Nothing in this document constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. GillenMarkets does not advise on the tax consequences of investments and you are advised to contact an independent tax advisor. Please note that the basis and levels of taxation may change without notice. This document is subject to updating, revision and amendment and should not be relied upon as individual investment advice. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. GillenMarkets allows employees to own shares in companies they issue recommendations on, subject to strict compliance with our internal rules governing own-account trading by staff members. Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up. The return on non-euro denominated investments may be affected by changes in currency exchange rates. All material presented in this document, unless specifically indicated otherwise is copyright to GillenMarkets. None of the material, nor its contents, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without prior express consent of GillenMarkets.