THE 50% PRINCIPLE

Richard Russell had some interesting commentary in his latest letter.  He covers the 50% principle:

One area that has always fascinated me is the concept that George Schaefer called “Dow’s 50% Principle.” The 50% Principle can only be applied to extended movements in the Dow (Schaefer only applied the Principle to the D-J Industrial Average). Schaefer was my mentor, a pioneering Dow Theory analyst, and a man who had a better “feel” or instinct for the primary trend of the market than anyone I have ever known or read about. The following is what Schaefer actually wrote about the 50% Principle.

“The 50% Principle is one that has never been fully explained to the public. The writer has never found a treatise on it in any book, magazine or newspaper article on Dow’s Theory. However, the editorials of both Dow and Hamilton strongly suggest that these men gave due consideration to what the Averages did at the halfway point of preceding major swings.”

Russell Comment: I have always kept the 50% Principle in mind during major swings of the Dow. The material below is taken from George Schaefer’s June 9, 1950 Special Report..

The following is a diagram and description from George Schaefers’ actual report, written on November 4, 1950. To my knowledge, this has never been shown before by me or anyone else. You might print it for reference or for historic value.

“After several years of research, I (Schaefer) have found a way to visualize the 50% Principle, which I will now pass on to you.

“Imagine a beam which has been balanced perfectly from a point at the center (see diagram). It will finally come to rest in an equally balanced horizontal position, which is the 50% level. Now suppose that different weights are applied at the ends A and B. These weights may be likened to economic forces in the market. One could be the sum total of all bullish forces, while the other could be the sum total of all bearish forces. The beam will now swing back and forth according to the influence of these weights.

“In seeking its new level, the beam is reflecting an appraisal of the weight at each end. If B, for example, swings above the 50% level and stays above it, the chances are that it will stay above it and have times when it will swing much higher. If, on the other hand, it swings below the 50% level in a convincing manner, the way is then clear for it to swing down much farther later on”.
……………………………………………..

This is Russell again — The great advance in the Dow began on October 9, 2002 at 7286. The Dow headed higher and by October 9, 2007, the Dow recorded its historic high of 14164.

This represented a rise of 6878 points. The halfway or 50% level of this rise was 10725. The question — would the Dow, on a decline, be able to hold above the 50% level of its advance?

The Dow declined, and on September 17, 2008, the Dow broke below the 10725 or halfway level of the great advance from 2002 to 2007. After breaking below the 10725 or 50% level of the advance from 2002 to 2007, the Dow then fluctuated back and forth above and below 10725 for several weeks — and then dropped decisively below 10725. Since then, the Dow has never been able to close above 10725. Thus, the 50% Principle turned bearish on September 17, 2008, and it remains bearish to this day.

My conclusion is that when the Dow broke below 10725, the “spine” of any remaining bullish forces was broken. After that, the long-term trend of the stock market and the economy are seen to be headed irresistibly down.

When will the decline end? This bear market will end the way all great bear markets have ended — at the level when blue chip stocks become “great values.” By great values I mean the Dow selling at less than 10 times earnings and with the dividend yield on the Dow in the 5-6% zone.

Great thoughts from an investing legend.  You can check out the Dow Theory Letters and more from Ruseel at www.dowtheoryletters.com