By
New
Low Observer
:
Attempts by Barron 's
to explain Dow Theory have failed miserably… ag ain. In the
September 29, 2012 article by Jacqueline Doherty titled "
Broken Dow Theory
," it is suggested that "A lagging transportation sector
historically has been considered a bad omen…" and then recites the
standard, sub-standard nomenclature "Le ss shipping means fewer
goods are being produced and purchased, which means the economy is
slowing and the stock market could be headed for a fall." Doherty
goes on to cite data from Bespoke Investment Group asserting that
even though the Transportation Index (
IYT
) has fallen behind the market in general, it may not mean that the
stock market, as represented by the S&P 500 (
SPY
), necessarily needs to follow the same script.
Fortunately, Dow Theory is very specific about how to interpret
the Dow Jones Industrial (
DIA
) and Transportation Averages since the publication of Robert
Rhea's book
The Dow Theory
. Nowhere in the rules of Dow Theory is there any indication that
the vacillations of the S&P 500 are remotely part of the
interpretation of the theory. Especially since the S&P 500 came
onto the scene over 60 years after the creation of the Dow
Industrials.
Despite the fact that there are some Dow Theorists who
frequently use the S&P 500 as a substitute for indications of a
rising or falling market (this isn't Dow Theory), there is little
evidence that using the additional index is necessary. Alternate
indexes are only necessary when and if the Dow Jones Industrial and
Transportation Averages no longer exist.
While the prevailing opinion is that the Dow Industrials isn't a
relevant index reflective of the market as a whole, a distinction
should be made between a "lagging" index and a "divergent" index. A
lagging index is one which is going in the same direction as the
other but is not increasing/decreasing at the same rate. A
divergence is when one index goes up while the other index is going
down. The chart below shows two failures and one divergence between
the Industrials and Transports.
(click to enlarge)
When one index cannot make new highs in accordance with the
other index, it should be considered a significant failure and a
warning sign. A perfect example is when the Transportation Index
made a new high in 2008 and the Industrial Index could not follow
through. The subsequent decline in both indexes was staggering.
In situations where there has been a divergence between the Dow
Industrials and Transports, it is the Transports that typically
leads the divergence to the upside or downside, meaning that the
Transports will provide a clue as to the potential market direction
in spite of the action of the Dow Industrials. Although
historically this has been the case,
Barron's
has unwittingly legitimized the view that the spread between the
Dow Industrials and Dow Transports is some form of Dow Theory. In
no way is this the case. In fact, in the period from 1896 to 1984,
the Transports have exceeded the Industrials, on a percentage
basis, in 15 out of 25 Dow Theory bull and bear market moves.
| Year |
DJI beat by |
DJT beat by |
|
|
Year |
DJI lost by |
DJT lost by |
| 1896 |
33.50% |
|
|
|
1899 |
-13.30% |
|
| 1900 |
|
51.00% |
|
|
1902 |
-6.40% |
|
| 1903 |
88.60% |
|
|
|
1906 |
-7.30% |
|
| 1907 |
24.50% |
|
|
|
1909 |
-5.30% |
|
| 1910 |
10.10% |
|
|
|
1912 |
-13.80% |
|
| 1914 |
78.70% |
|
|
|
1916 |
-3.10% |
|
| 1917 |
64.80% |
|
|
|
1919 |
-26.00% |
|
| 1921 |
18.40% |
|
|
|
1922 |
|
-2.30% |
| 1923 |
192.30% |
|
|
|
1929 |
|
-3.80% |
| 1932 |
|
15.60% |
|
|
1937 |
|
-21.40% |
| 1938 |
|
20.60% |
|
|
1938 |
|
-6.40% |
| 1939 |
|
20.30% |
|
|
1939 |
-5.30% |
|
| 1942 |
|
64.40% |
|
|
1946 |
|
-16.50% |
| 1947 |
|
39.40% |
|
|
1948 |
|
-20.50% |
| 1949 |
|
92.50% |
|
|
1953 |
|
-6.50% |
| 1953 |
3.80% |
|
|
|
1956 |
|
-27.80% |
| 1957 |
|
819.90% |
|
|
1959 |
|
-12.40% |
| 1960 |
5.80% |
|
|
|
1961 |
-2.90% |
|
| 1962 |
|
48.80% |
|
|
1966 |
|
-7.00% |
| 1966 |
|
19.20% |
|
|
1968 |
|
-22.30% |
| 1970 |
|
82.40% |
|
|
1972 |
|
-14.50% |
| 1974 |
|
10.00% |
|
|
1976 |
-13.10% |
|
| 1978 |
|
86.50% |
|
|
1981 |
|
-10.60% |
| 1982 |
|
44.00% |
|
|
1983 |
|
-9.70% |
| 1984 |
|
177.80% |
|
|
1984 |
|
-31.00% |
|
|
|
|
|
|
|
|
|
|
|
DJI |
DJT |
|
|
|
DJI |
DJT |
|
Total
|
520.50%
|
1592.40%
|
|
|
Average:
|
-9.65%
|
-14.18%
|
The table above reflects the percentage by which the respective
indexes exceeded the other from either the bull market low or the
bear market top. In the timeframe indicated above, the Transports
have routinely exceeded the Industrials to the upside by nearly
three times. The same is true for Dow Theory bear market moves
where the Transports have excessive downside moves as compared to
the Dow Jones Industrial average by nearly 50%.
The pattern of excessive gains and losses in the Transports
versus the Industrials has remained the case since 1984. As an
example, at the peak in 2007, the Dow Industrials declined -54%
while the Transports declined -60%. On the rise from the 2009
bottom, the Industrials and Transports registered gains of +110%
and +162%, based on their respective peaks. Excessive gains and
losses by the Transports above that of the Industrials,
demonstrates that the Transports usually act as a leading indicator
of market direction.
It should be noted that before the work of
Wall Street Journal
editor William Peter Hamilton and author Robert Rhea on the
topic
of Dow Theory, Charles H. Dow (co-founder of the
Wall Street Journal
) created and analyzed the Rail Index (now Transports) without the
existence of the Dow Industrials for 12 years, from 1884 to 1896,
for indications of market direction. Those 12 years are the basis
of what Dow was able to formulate his observations on the
market.
Unfortunately, the
Barron's
article goes on to quote a CIO who states that the "Nasdaq 100 and
S&P 500 are better leading indicators than the transports."
Based on the available data, the Nasdaq 100 has not been able to
exceed the all-time high set in January 2000. Additionally, the
S&P 500 has not managed to exceed the all-time high set in
October 2007. In the bull market run since the 2009 low, the
Transportation Average has managed to exceed its all-time high
unlike the Nasdaq 100 and S&P 500.
Finally,
Barron's
quotes data from Bespoke which reviews, "period s when the S&P
500 exceeded the transport index by 10 percentage points over a
50-day trading period. Going back to 1928, the S&P 500 gained
1% in the subsequent six months, not awful although below the
average six-month gain of 3.5%." Using a "50-day trading period" to
arrive at a conc lusion about the next six months is inadequate in
making even a cyclical determination of a bull or bear market based
on Dow Theory, let alone a secular indication. Dow Theory is about
the primary trend of the market, whic h tends to last from 3-4 1/2
years at a time.
In order to make a "complete" secular and cyclical analysis
based on Dow Theory, interpretation should begin at the prior dual
Industrial and Transport peaks in 2007/2008, at minimum. Until
there is a dual Industrial and Transport new high, cyclical new
highs in one index or the other would be a bear market reaction, as
indi cated in our August 9, 2011 note titled "
Bear Market Rally Targets
." Our indication that a bear market rally was about to take place
was with 2% of the October 3, 2011 low, giving full opportunity to
seek out new investment opportunities before the bear market rally
to the current peak in the Industrials. The current divergence of
the two indexes is confirmation of the fact that we're still in a
bear market rally until the prior 2009-2011/2012 highs are exceeded
for a cyclical bull market and all-time highs for a new secular
bull market.
Until 1956,
Barron's
would include Dow Theory analysis in the Market Laboratory section
every week. Since 1956, Dow Theory would show up only in feature
articles from experts on the topic. Now, it seems that anyone
making mention of either the Dow Industrials or Dow Transports can
suffice as knowledgeable on the topic of Dow Theory.
Naturally, there are many critics who adamantly speak out
against Dow Theory, which is surprising since Charles H. Dow's work
of creating the
Wall Street Journal
along with his theories of the stock market are the foundation of
both fundamental and technical analysis in the United States.
However, even without knowing the nuances of Dow Theory, the
critics are justified in their claims, especially when the
"analysis" is so incomplete and inaccurate.
If the goal is to do away with Dow Theory and eliminate the
indexes, then that is fine. However, if the goal is to actually
interpret the theory in some mediocre fashion, th en it should be
done by someone who has actually studied the topic extensively.
Barron's
, a place where William Peter Hamilton and many other great Dow
Theorists were prominently featured, is doing a disservice by
connecting unrelated and disparate themes and suggesting that
somehow the theory is "broken."
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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