What Is Dow Theory Telling Us Now? [Dow Jones Industrial Average(INDEXDJX:.DJI)]

wall-street-etfChris Ciovacco: Stock prices have a high correlation to economic activity and earnings. History tells us bear markets are often kicked-off by recessions. The head of one of the nation’s closely watched manufacturing indexes says a recession does not appear to be imminent. From ThomasNet News:

In a one-on-one interview with ThomasNet News at the recent International Supply Management Conference in Las Vegas, Bradley Holcomb, chair of the Institute for Supply Management (ISM) Manufacturing Business Survey Committee, said the U.S. manufacturing sector will see revenue and production output increases and be aided by moderate supply price growth and fewer economic and political headwinds. “The message is positive for the rest of this year,” said Holcomb, based on his analysis of the latest quarterly survey of 350 purchasing and supply executives at medium and large manufacturing companies across the country who report business conditions to ISM. “The weather had some short-term impact, but it’s mostly behind us,” Holcomb added. “There are rising levels of confidence among consumers and CFOs, and this confidence is real. There is pent-up demand in the housing market, and our forecast shows contained, nominal price increases for the foreseeable future.”

Dow Theorists Become More Optimistic

On April 4, we discussed a concerning signal for stock investors and the economy based on Dow Theory. The signal has changed and this article covers the improvement in the observable evidence. Before we cover the updated charts, it is important to revisit the fundamental concepts they convey. Dow Theory is based on a series of Wall Street Journal articles written by Charles Dow. The basic tenets are easy to understand. Charles Dow believed that:

  1. In order for industrial companies to increase their earnings, they had to produce and sell more goods.
  2. If industrial companies are selling more goods, then transportation companies must be delivering more goods to retailers and wholesalers.
  3. Therefore, in a healthy economy, both industrial companies and transportation companies should be experiencing revenue growth.
  4. If industrial and transportation companies are growing their revenues, then the industrial and transportation stocks should be attractive to investors.
  5. If industrial and transportation companies are doing well and are attractive to investors, both the Dow Jones Industrial Average and the Dow Jones Transportation Average should be making new highs in unison, serving to confirm a healthy economy.

Signal: That Was Then

In April we described the concerns rooted in Mr. Dow’s theory as follows:

If investors believe industrial and transportation stocks are healthy and thus, attractive investments, that speaks to demand. When demand is strong, stock prices rise. Friday, the Dow Jones Industrial Average (DJIA) once again was unable to post a new closing high, leaving an economic divergence in place relative to the high made in the Dow Jones Transportation Average (DJTA) on April 1, 2014. The 50-day moving average, shown in blue below, helps us monitor the intermediate-term trend in the Dow Jones Industrial Average. The flat look of the Dow’s 50-day is indicative of economic indecisiveness on the part of investors. The inability of the Dow to post a new closing high is an economic yellow flag according to Dow Theory (see point 5 in the list above).

Signal: This Is Now

In Monday’s session both the Dow Jones Industrial Average and the Dow Jones Transportation Average made new highs. Therefore, the concerning economic non-confirmation has been taken off the table.

Pages: 1 2 3

Leave a Reply

Your email address will not be published. Required fields are marked *