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 by subscribing to several investment services that carried tips and other information of varying degrees of reliability. The plethora of publications coming his way finally struck him as “a little wasteful.”41
He decided to figure out which publication was the best and to subscribe to just that one. In 1928, he started to keep track records on the twenty-four most widely circulated services and continued to do so for four years. That period ran from the height of the great bull market of the 1920s, to the crash of 1929, to the cascading bear market of 1931–32. As the appalling drama unfolded, it seemed to come as a total surprise to the services Cowles was subscribing to. He decided to find out whether the failure was something endemic to the advisory business or just a reflection of the shortcomings of those services.
Ironically, a neighbor of Cowles in Colorado Springs, Robert Rhea, was in the process of reaching exactly the opposite conclusion from Cowles. Rhea, who had been permanently disabled while serving in the aviation branch of the Signal Corps during World War I, was later to emerge as the most famous exponent of Dow Theory. A diligent student of Hamilton’s writings, he launched a market letter called “Dow Theory Comment” in mid-1932. The letter put Dow Theory on the map and became so popular that its subscription list reached 6,000, a large number in those days, particularly in view of the depressed state of the stock market and the economy.
Although Rhea made few original contributions to Dow Theory, he is generally credited with having transformed Hamilton’s scattered observations into a structured set of ideas. He also traded successfully enough in the market to cover the large medical bills that had accrued during his many years of disability.
Rhea never pretended that market forecasting was simple. He wrote in 1935:
Those who try to profit from the advance and decline of security prices are perplexed perhaps 90 % of the time. And it seems that perplexity increases with experience… [U]nvarying cocksureness on the part of traders or investors is a badge of incompetence. There is, nevertheless, a time and place for certainty where the market is concerned, but such times and places are few and far between.42
Rhea identified two “times and places for certainty.” He called the bottom of the great bear market on the exact day it hit its low, on July 8, 1932, and then predicted the top of the market in 1937. We do not know whether his uncanny forecasting abilities would have continued into the future, because he died in Kansas City in 1939.
Meanwhile, in 1931, Alfred Cowles had set out on his own quest to determine whether stock prices are predictable. His achievements were noteworthy in his own time, and few scholars of any era have been as thorough, as creative, and as helpful to others. The amateur converted himself into a distinguished professional.
Cowles knew what he wanted to do but was uncertain about how to go about it. He consulted his friend Charles Boissevain, a Dutch biochemist with mathematical training who was chief of research at the Colorado Foundation for Research in Tuberculosis, where Cowles was a director and treasurer as well as a patient. Boissevain must have been a colorful and stimulating companion. At one time the champion sculler of Holland, he suffered from both tuberculosis and asthma and had come to Colorado for relief. A contemporary described Boissevain in these words: “He had a brilliant mind and knew what research was all about. Just one caveat though: Webb [the head of the foundation] would have to take care to keep Boissevain on the track. He had so many ideas, so much scientific curiosity, that he might be prone to start up too many hares and not all of them in the tuberculosis field.”43
Boissevain referred Cowles to Harold Davis, a professor of mathematics at Indiana University who shared Cowles interest in economics and statistics.
Cowles asked Davis whether it would be possible to compute a mathematical procedure called linear regression with twenty-four variables, an unusually large number. Davis replied that he could not imagine why anyone would want to perform a regression with that many variables, but he helped Cowles acquire a Hollerith machine, IBM’s most advanced punch-card computer in the early 1930s. Despite Davis’s skepticism, he helped Cowles to perform the necessary calculations.
Davis also urged Cowles to get in touch with the Econometric Society, an organization established two years earlier to encourage scholars interested in combining the science of mathematical statistics with economics. Davis was confident that Cowles would find the guidance he was seeking from among the society’s membership of about a hundred distinguished economists and mathematicians. With Cowles’s still ample fortune in mind, Davis mentioned that the society was short of funds and could afford only occasional small meetings and that the members were eager to publish a journal that would bring their work to the attention of other scholars in their own and related fields.
Cowles immediately wrote to Professor Irving Fisher of Yale, President
Bloom (1974).
Bloom (1974).
Bloom (1974).
Rhea (1935).
Clapesattle (1984).
