Capital Ideas. Bernstein Peter L.

prices, once under way, will tend to persist until the market itself sends out a signal that these trends are about to lose their momentum and go into reverse. Dow’s best-known statement on the subject appeared in a Journal article in 1901:

      A person watching the tide coming in and who wishes to know the exact spot which marks the high tide, sets a stick in the sand at the points reached by the incoming waves until the stick reaches a position where the waves do not come up to it, and finally recede enough to show that the tide has turned.

      This method holds good in watching and determining the flood tide of the stock market… The price-waves, like those of the sea, do not recede at once from the top. The force which moves them checks the inflow gradually and time elapses before it can be told with certainty whether the tide has been seen or not.35

      Recognizing turns in the tide is less simple on Wall Street than it is on the beach. The market does fluctuate. Dow theorists boast that they can identify the very moment when what appears to be only a slight fluctuation is actually the first sign of the reversal of a major trend. They do not always agree among themselves, however. Disputes often arise over whether a slight fluctuation away from a trend is just a temporary setback – a “correction,” in market patois – or the onset of a new trend. Sometimes the signal appears so late that the main trend has almost exhausted itself, and stock prices are about ready to turn around and start a new trend headed in the other direction.

      Even people who have never heard of the Dow Theory are familiar with the Dow Jones Averages, Charles Dow’s most lasting contribution to finance. This was the first attempt to create some sort of aggregate indicator of stock-market trends. Although other averages have since appeared, notably those from the Associated Press, the New York Times, and Standard & Poor’s, the Dow Jones Averages are still what most people turn to when they want to know “How’s the market doing?”

      The first Dow Jones Average appeared in the Afternoon News Letter on July 3, 1884. It consisted of the closing prices of eleven companies: nine railroads and two industrials. Dow’s idea was to provide an overall measure of the performance of active companies, at a time when an average day’s activity on the New York Stock Exchange was about 250,000 shares. Although today’s average volume is over 100,000,000 shares a day, 250,000 shares represented at the time a higher level of activity relative to the number of shares listed on the Stock Exchange and available for trading.

      In 1882, Dow predicted that “The industrial market is destined to be the great speculative market of the United States.”36 He recognized that his list of companies would change as time passed. After twelve years of constant revision of the composition of the Dow Jones Average, he published the first strictly industrial list on May 26, 1896.

      Of twelve industrials included in that list, only one still appears in the Industrial Average: General Electric. The other eleven were American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling and Cattle Feeding, Laclede Gas, National Lead, North American, Tennessee Coal & Iron, US Leather preferred, and US Rubber. Later listings included such diverse items as Victor Talking Machine, Famous Players Lasky, and Baldwin Locomotive.

      The twelve stocks in the first industrial list included all the industrial companies then traded on the New York Stock Exchange. The other companies listed consisted of fifty-three railroads and six utilities. Shares of banks and insurance companies then traded over-the-counter rather than on the floor of the New York Stock Exchange.

      The term “industrial” is really a misnomer, because not all of the companies listed as industrials were industrial companies. They were simply all the companies that were neither railroads nor utilities.37 Dow Jones published separate averages for the railroads and the utilities.

      The sparseness of industrials relative to rails in the list is evidence of the boldness of Dow’s foresight about the industrial market, as well as an indication of the importance of railroads to the American economy in the late nineteenth century. It reflects something else as well: Most industrial companies did not need as much capital as the rails, which required huge financing for their rolling stock and right-of-way.

      In those days, industrial companies tended to rely on a combination of debt and their founders’ wealth to finance their growth. This was partly a matter of choice, as incorporation did not offer major benefits to owners at that time. But it was partly because, as one historian of the period has noted, “the securities of industrial corporations were regarded as peculiar, unstable, and speculative. Even the largest and most visible firms were not ‘public’ corporations.”38 For example, two industrial giants of the period, the Singer Manufacturing Company and McCormick Harvesting Machine (later International Harvester), were still closely held corporations.

•••

      Dow died at his home in Brooklyn in 1902, just nine months after Dow, Jones & Co. had been sold to Clarence Barron for $130,000 – only $2,000,000 in today’s purchasing power. About a year later, Samuel Nelson, publisher of Nelson’s Wall Street Library, published several of Dow’s editorials in a book called The ABC of Speculation. Nelson is believed to be the first to use the expression “Dow Theory.” Dow himself never used it.

      In 1903, William Peter Hamilton took over as editor of The Wall Street Journal. Hamilton was a Scottish journalist who had joined the paper as a reporter in 1899, while Dow was still there. As editor, he followed Dow’s practice of writing almost all the daily editorials himself and continued to do so until his death in December 1929.

      Hamilton repeatedly stressed a central idea of Dow Theory that prices on the New York Stock Exchange are “sufficient in themselves” to reveal everything worth knowing about business conditions. Here Hamilton was anticipating a radical concept that was to appear long after his death. In the 1960s, a group of college professors would develop the Efficient Market Hypothesis, based on the notion that stock prices reflect all available information about individual companies and about the economy as a whole. The Efficient Market Hypothesis, however, also looks back to Bachelier, for it assumes that information is so rapidly reflected in stock prices that no single investor can consistently know more than the market as a whole knows. Hamilton, on the contrary, believed that the market itself revealed what stock prices would do in the future.

      On October 21, 1929, just before he died, Hamilton predicted the end of the bull market of the 1920s in an editorial titled “The Turn in the Tide,” a title that recalled Dow’s view of market behavior. Hamilton had made similar predictions of impending disaster in January 1927, June 1928, and July 1928. So “The Turn in the Tide” was a lucky call. The worst day in the history of the Stock Exchange occurred just four days later. In the days ahead, values were to fall 90 percent from their 1929 peak before hitting bottom in 1932.

      One of the victims of the crash was Alfred Cowles 3rd, a wealthy man whose father and grandfather had been major stockholders and executives of the Chicago Tribune Company. He was born in Chicago in 1891 and, following family tradition, attended Yale. He graduated in the class of 1913 and went to work as a reporter for the Tribune in Spokane.

      Suddenly Cowles came down with tuberculosis. His family shipped him off to Colorado Springs for treatment, which, according to Cowles, “consisted mostly of resting in bed and hoping for the best.”39 The cure, uncertain as it may have been, ultimately succeeded. After ten years in Colorado Springs, he rejoined his family in Chicago. He was 93 years old when he died in 1985.

      An interviewer who visited Cowles at his ten-room Palm Beach home in April 1970 described him as “.. about six feet tall, and his thin gray hair is combed straight back. His skin is slightly splotchy and freckled, the neck crepey… ‘I’m getting along,’ he said, ‘and for a man with a plastic aorta in my heart and a game leg, I’m doing all right.’”40

      Around 1926, while still in Colorado Springs, Cowles had begun to help his father with the management of the family’s financial affairs. He kept in touch with what was happening in the market

35

Wendt (1982).

36

Wendt (1982).

37

Today, the industrials include all stocks that are not utilities, railroads, airlines, or truckers.

38

Kopcke (1989).

39

Bloom (1974).

40

Bloom (1974).