Roger W. Babson's Theory

Continued from...A Unique Quality of Forecast

But the idea is widely held. There is no intention here to arouse or encourage controversy, and if I take an example from Roger W. Babson and his book on Business Barometers, he will, I am sure, readily understand that it is not intended in criticism or depreciation of his highly sincere work. It is only fair to Mr. Babson, to say, also, that the extract I give here was published in 1909 (the italics are Mr. Babson's):

"A slowly sagging market usually means that the ablest speculators expect in the near future a period of depression in general business; and a slowly rising market usually means that prosperous business conditions may be expected, unless the decline or rise is artificial and caused by manipulation. In fact, if it were not for manipulation, merchants could almost rely on the stock market alone as a barometer, and let these large market operators stand the expense of collecting the data necessary for determining fundamental conditions. Unfortunately, however, it is impossible by studying the stock market alone to distinguish between artificial movements and natural movements; therefore, although bankers and merchants may watch the stock market as one of the barometers, yet they should give to it only a fair and proportional amount of weight." .

-Business Barometers Used in the Accumulation of Money, by Roger W. Babson; second edition, 191O.

Mr. Babson's Chart

What sort of barometer should we have if we had to make allowances for a tube of mercury that was too short, or for a general lack of accuracy in the delicate and sensitive mechanism of the aneroid? The stock market barometer is not perfect, or, to put it more correctly, the adolescent science of reading it is far from having attained perfection. But it is not imperfect in the sense Mr. Babson here assumes. It does discharge its function of prediction, when viewed over any reasonable length of time, with almost uncanny accuracy. Let us take a few examples from Mr. Babson's own picture chart, those composite "plots" above and below a consistently rising line representing the steady increase in a growing country's wealth, and we shall see how the stock market predicted each of them before Mr. Babson had the material to draw them in the squares of his instructive and striking chart. To those who are unfamiliar with a publication so interesting it may be said that he divides his chart with columns for each month of the year vertically, and completes his squares horizontally with numbered lines showing the area covered by all the factors of business, above or below a gradually rising middle line across the chart representing the growing wealth of the country.

How the Stock Market Predicted

It will be observed that where these areas are shallow they tend to become broader in time consumed, and where the time to complete the area is less the depression or expansion is deeper or higher, as the case may be, the black areas above or below being assumed to balance each other, at least approximately. One of these black areas of depression shown in the Babson chart began in 1903, only developing recognizable space in the latter part of that year, and continued throughout 1904, finally emerging above the line of growing wealth in the earlier part of 1905. The stock market anticipated this area of business depression, for a primary bear swing began in September, 1902, and ran until the corresponding month of 1903. Mr. Babson's area of depression was still ruling when the market became mildly bullish, in September, 1903, and strongly bullish before the following June; while the Babson area of depression was not completed till the end of that year -1904. The Babson chart does not show any great degree of expansion until 1906, although it foreshadows it in September, 1905. But the stock market barometer foresaw all Mr. Babson's expansion, and the long bull market continued up to January, 1907, overrunning itself - a tendency of bull markets and bear markets alike.

A True Barometer

Mr. Babson's area of expansion reached its high maximum in 1907, when a bear stock market swing had already set in, continuing for eleven months until early December of that year, predicting that length of time ahead of Mr. Babson's truly calculated area of depression, which was deep, but not long in duration, and lasted till the end of 1908. His subsequent expansion area above the line did not begin to show itself in market strength until the end of July of 1908; but the stock market barometer once again foretold the coming prosperity in a bull market which had its genesis in December, 1907, and its culmination in August, 1909, beginning from that time to predict with equal accuracy, and well in advance, Mr. Babson's next period of depression.

Surely this shows that the stock market is a barometer, and that the Babson chart is more strictly a record, from which, of course, people as intelligent as its industrious compilers can draw valuable guidance for the future. To use a much-abused word, the stock market barometer is unique. You will remember that "unique" is a word which takes no qualifying adjective. Our barometer is not rather unique, or almost unique, or virtually unique. There is just one of it, and it cannot be duplicated. It does predict, as this simple illustration has shown, the condition of business many months ahead, and no other index, or combination of indices, can assume to do that. Our highly scientific and competent Weather Bureau often explodes the fallacy of any assumed radical change in general weather conditions. It does not pretend to go back to the glacial age. It tells us that there have been droughts and hard winters before, coming at uncertain and incalculable intervals. When it attempts specific prophecy - a single particular from its immense collection of generals - it is merely guessing. Does anybody who happened to be in Washington at the time remember the "fair and warmer" weather prophesied over the Taft inauguration? I went over the Pennsylvania Railroad on the following day, when the storm had leveled every telegraph pole between New York and Philadelphia. It was even said that some of the special trains had so far missed the parade that they were not in Washington then. Even the aneroid barometer can only forecast a limited number of hours ahead, according to the atmospheric pressure.

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From The Stock Market Barometer by William P. Hamilton, published in 1922