Some Chartists See Gloom in the Dow’s Pattern
You’ve heard of Twin Peaks? On Wall Street, the biggest topic of conversation now is Three Peaks . . . and a Domed House.
The term refers to a pattern traced by the Dow Jones industrial average since mid-1989. Based on the work of George Lindsay, one of the most respected market analysts of all time, this chart pattern has frequently presaged severe bear markets.
The Dow chart since mid-1989 shows three distinct peaks. The even higher “domed house” part of the pattern is what the Dow is tracing now, say Lindsay’s followers. From this dome--which may top as early as May 17, according to some analysts--the Dow will plunge through the lows reached last October.
At least, that’s how some bearish chart readers see it. The stock market’s bulls insist that Three Peaks is just a fairy tale. But Lindsay’s followers argue that this is the strongest sell signal they’ve seen in many years.
Many of those Lindsay-influenced analysts gathered in Santa Barbara over the weekend for the 16th annual Market Technicians Assn. conference. As they do each year, the 115 attendees recognized one of their own for excellence in technical market analysis. This year, the award was given posthumously to Lindsay, who died Aug. 6, 1987.
A technical analyst is someone who tries to predict stock moves based on the market’s action in the past--patterns of key indexes on charts, for example, or number of stocks rising at any time versus number falling.
Technicians don’t care about company earnings, dividend yields or other fundamental measures of market value. They believe that the market ultimately listens to its own internal voice--and that the same patterns of bull and bear moves are frequently repeated over the decades, fueled by repeating waves of investor optimism and pessimism.
The Three Peaks pattern is one that Lindsay saw at least 12 times in the 120 years of market charts he had amassed, says Frank Barbera, a technical analyst for Financial News Network in Los Angeles. While the pattern did not precede every bear market--it worked in 1968-69, for example, but not 1973--it did predict enough market tops to cause Lindsay to emphasize its significance, Barbera says.
Because Lindsay’s technical work overall was considered so strong, the reappearance of the Three Peaks pattern at a time of general market confusion has given more technicians a good reason to cling to the bearish case.
Justin Mamis, a veteran technician with Gordon Capital Management in New York, says no one since Lindsay has been able to repeat his success in predicting market trends. “The way he called tops and bottoms was uncanny; it was to the date,” says Mamis, who was a friend of Lindsay. “No one is sure how he did it.”
When he saw the current Three Peaks pattern in the charts not long ago, Mamis says he was struck by how “it fit Lindsay’s work perfectly.”
Mamis believes that the pattern will indeed be played out as Lindsay had projected:
* The Dow, at 2,938.86 now, will soon complete the dome pattern. Some analysts predict a peak May 17; others say stocks could churn for months, peaking in August.
* From the peak, the Dow will initially fall below the low of 2,365 reached last October, when worries about the Gulf War and the economy caused the market to crumble.
* A strong rally will follow the new lows, reviving talk of a long-term bull move. Then the market will plunge anew to even lower lows, probably under Dow 2,000.
* Sometime in 1994 or 1995, Mamis says, the market will finally bottom, laying the groundwork for a bona fide bull market.
There are, of course, plenty of Wall Street analysts who believe that the chart patterns are predictive of nothing.
“What about all of the positive events influencing the markets?” these analysts ask--the decline of communism, low inflation and global free-trade movements, for three. How can the charts know about those things?
What’s more, even some veteran technicians argue that Three Peaks is overruled by one of the most bullishly fundamental events the market can hope for: The sharp decline in interest rates the past year, as engineered by the Federal Reserve.
Historically, whenever the Fed has cut its key discount rate three times in a row, the market has rallied strongly in ensuing months. The Fed’s rate cut last week, to 5.5% from 6%, was the third since December.
“I’m not going to go along with any bearish (chart) connotations when I know that history and the Fed are both against a down market now,” says Gene Jay Seagle, a well-known technical analyst at Gruntal & Co. in Stamford, Conn.
Seagle also argues that many of the chart patterns of the past are no longer valid because technology is driving much faster market moves today. “The volatility changes the outlook for many technical formations,” he says.
Mamis, however, says long-term chart patterns are no different than they’ve ever been because human nature is no different. “I will testify in court that the charts take just as long to make bottoms and tops as they ever did,” he says. “What’s changed is just the intra-day volatility of the market.”
To ignore the charts, Mamis says, is to ignore “the natural rhythm of the markets.”
In fact, what he is predicting with the Three Peaks scenario is very similar to the stock market that many fundamental analysts have long expected we would have in the early 1990s: A wild sequence of bull and bear markets, rather than the steady uptrend that investors got used to from 1982 to 1987 and again from 1988 to 1990.
A return to a rapidly repeating cycle of bull and bear markets won’t be much fun for many investors, Mamis says, but that type of market actually is the rule rather than the exception historically, he notes. That is what prevailed from 1975 to 1982, for example.
Investors who know how to pick good stocks will flourish in this period, Mamis says, as will those who are expert market timers.
For long-term investors, the only option is to steel yourself for this cycle and own only those companies that you are confident will be thriving by the time the next super bull market begins in the mid-’90s.
Briefly: Robert Prechter, a technical analyst who became one of the most famous in the mid-’80s because of his bull market predictions, has resurfaced recently after dropping out of the scene for two years. Prechter, who attended the MTA meeting in Santa Barbara over the weekend, is sticking with his long-held view that 1987 was the bull market peak and that stocks’ recent moves are nothing more than noise. He sees the Dow index ultimately plunging below the low of 1,738.74 reached in October, 1987
. . . Some followers of the Dow index are chuckling over Dow Jones & Co.’s decision to toss Navistar out of the 30-stock index, effective today, replacing it with Caterpillar. (Also today, Disney is replacing USX in the Dow, and J. P. Morgan is replacing Primerica.)
Truck-maker Navistar is a virtual penny stock, at $3.625 a share, so it’s understandable why Dow Jones no longer thinks it’s fit for the Dow. But Dow Jones also threw Chrysler out of the index when it was a penny stock in 1979. Chrysler then soared from $1.875 in 1980 to $48 by 1987--making it one of the hottest stocks of the 1980s.
Michael O’Higgins, author of the book “Beating the Dow,” says many of the dog stocks that Dow Jones has dropped from the index went on to greatness--including IBM, dropped in 1939. It wasn’t returned until 1979.
Three Peaks and a Domed House? Some market chartists say they have spotted a pattern in the Dow Jones industrial average that has historically presaged severe declines. The patttern is called “three peaks and a domed house.” The chartists now believe the market is completing the dome, and will soon plunge.
Dow Jones industrial average, monthly close: October 1989: Peak 1: 2,791.19 January 1990: Peak 2: 2,810.15 July 1990: Peak 3, 2:999.75 Top of the Dome?: Friday close: 2,938.86
