Wednesday, July 15, 2009

Hamilton, The Stock Market Barometer

Here’s a change of pace, compliments of Google Books: The Stock Market Barometer: A Study of Its Forecast Value Based on Charles H. Dow’s Theory of the Price Movement. With an Analysis of the Market and Its History Since 1897 by William Peter Hamilton, editor of The Wall Street Journal (Harper, 1923). Now that’s a mouthful.

Hamilton was the popularizer of Dow theory in the 1920s. Dow theory merits a blog post of its own; I’d rather wait to analyze the words of Dow himself. Moreover, the general thesis of the book is by now old hat—that the stock market is the barometer of the country’s, even the world’s business and that Dow theory shows us how to read the barometer. There’s no need to rehash the familiar. But the book is eerily timely, and since it is in the public domain I can quote from it extensively. I’ve chosen some passages that I think may resonate with today’s investors and traders; most of the excerpts contain quotable one-liners.

Hamilton starts by acknowledging the cycle of panic and prosperity. His description of this cycle rings true today, even if not in every detail. “Prosperity will drive men to excess, and repentance for the consequences of those excesses will produce a corresponding depression. Following the dark hour of absolute panic, labor will be thankful for what it can get and will save slowly out of smaller wages, while capital will be content with small profits and quick returns. There will be a period of readjustment like that which saw the reorganization of most of the American railroads after the panic of 1893. Presently we wake up to find that our income is in excess of our expenditure, that money is cheap, that the spirit of adventure is in the air. We proceed from dull or quiet business times to real activity. This gradually develops into extended speculation, with high money rates, inflated wages and other familiar symptoms. After a period of years of good times the strain of the chain is on its weakest link. There is a collapse like that of 1907, a depression foreshadowed in the stock market and in the price of commodities, followed by extensive unemployment, often an actual increase in savings-bank deposits, but a complete absence of money available for adventure.” (p. 3)

Given that there are business cycles, can one use cycle theory to time the market or the economy? Hamilton answers unequivocally in the negative. For instance, the twenty-year cyclists prophesied a minor crisis around 1903 and a major panic in 1913, but nothing happened in either of those two years. “Indeed, the volume of the world’s speculative business was not large enough to make a crisis in those years. It is reasonably certain that a smash cannot be brought about unless an edifice of speculation has been constructed sufficiently high to make a noise when it topples over.” (p. 119) Cycle theorists have to keep “humoring” their forecasts. Hamilton concludes: “. . . this whole method of playing the cycles looks to be absurdly like cheating yourself at solitaire. I can understand stringent rules, arbitrary rules, unreasonable rules, in any game. But my mind fails to grasp a game where you change the rules as you go along.” (p. 119) There is admittedly a rough periodicity to market swings, “but if we begin to twist them into some mathematically calculable, regularly recurring ‘cycle,’ the next main movement, up or down, will leave us all adrift, with nothing to hold on to but an empty theory and an empty purse.” (p. 124)

Hamilton also offers a word of caution for our times: “At the turn of a bear market there is a chaos of knowledge of all kinds, and an almost inextricable confusion of opinion, which is gradually resolving itself into order. It follows that speculators and investors tend to anticipate the market movement and often look too far ahead. It would be possible to offer endless instances of people who lost money in Wall Street because they were right too soon.” (pp. 130-31)

And on the amateur vs. the professional: “[I]n the long run, in nearly all games, the professional will win oftener than the amateur. He will win more when there is anything considerable at stake and he will lose less when losses are inevitable.” (p. 169) By ‘professional’ Hamilton does not mean only a person who works on Wall Street. “Of the many successful speculators who fight for their own hand, like Hal o’ the Wynd, those who, not being members of the Stock Exchange or partners in any brokerage house, are therefore obliged to concede the broker’s commission and the market turn, all sooner or later become, in any intent, professionals. They devote to the business of speculation exactly the jealously exclusive attention which a successful man gives to any kind of business. The outsider who takes only ‘an occasional flutter’ in the stock market, however shrewd and well informed he may be, will lose money in the secondary swings, where he is pitted against the professional. He cannot recognize the change in movement quickly enough to adapt his attitude; he is usually constitutionally averse to taking a loss where he has previously been right. The professional acts upon the shortest notice, and reactions or rallies give little notice.” (p. 146)

Finally, a word on speculation. “. . . I hope the day will never come when the speculative instinct is not at least latent in an American’s mind. If ever that day does come, if ever prohibition extends to the taking of a chance involving the risk of whole or partial loss, the result may be ‘good’ Americans, but of a merely negative type of goodness. If as you enter Wall Street you will pause a moment in Broadway, to look through the railings of Trinity churchyard, you will see a place full of good Americans. When speculation is dead this country will be dead also.” (p. 253)

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