Dow Theory is the oldest US market-timing theory. It was created
at the turn of the 20th century when Charles H. Dow and William
Peter Hamilton were fashioning a methodology for staying on the
right side of the long-term trend. In their simple wisdom they
surmised that if both the companies producing goods and moving them
to the markets were increasing in value, then the economy must be
doing well and thus the trend would remain higher.
To track this behavior they created the
Dow Jones Industrial
(INDEXDJX:.DJI) and Rail averages with the latter eventually
(INDEXDJX:DJT). There were some rules added with the most important
being the confirmation, or lack thereof, between the two averages.
If one moved to new highs the other needed to confirm that behavior
and do so within a reasonable period of time.
There are several Dow Theory newsletters still published, and
though each can offer different interpretations about the market,
they all take the original assumption for granted: that if the
companies producing goods and moving them to markets are increasing
in value, then the market will move higher. More importantly,
another basic assumption is that the Dow Jones Industrial Average
and the Transportation Average continue to reflect those two
important parts of the economy -- but do they?
Although there is little to argue with in terms of the
Transportation Index's composition, the Industrial Average is a
different story. Less than a month ago, it underwent a significant
shake-up that fundamentally altered it, making the financials the
dominant sector. Have we really matured to the point where the
financial sector can be considered our nation's primary product?
Although it is called the "industrial index," no longer are
industrials the largest sector.
In fact, consumer discretionary isn't all that far behind the
industrial sector at this point. The financial and discretionary
sectors now account for 40% of the Dow Jones Industrial Index. Is
that what Dow and Hamilton would have considered as requiring
tracking some 100 years later?
) teamed up with others to take the dominant stake in the DJIA, we
probably should have seen this coming. More and more, the Dow is
turning into a miniaturized version of the
S&P 500 Index
To be fair, there clearly are some differences still, but the gaps
are narrowing, not widening. Within a few years it will probably
make sense to pull the name "Industrial" from the index since it
clearly is a misnomer, but the value of the name will never allow
that happen. Instead, it will morph into something totally
different than what it began as, which poses the question: Is Dow
Theory, as we know it, dead?