It wasn’t too long ago when the Dow Theory flashed a sell signal.
To reiterate, the Dow Theory simply states that in an uptrend, or downtrend, two popular stock indices must follow each other. For example, if the Dow Jones Transportation Index moves downward, the Dow Jones Industrial Average must follow in a similar direction for the overall trend to be considered down.
In these pages, on September 26, 2012, I wrote that the Dow Theory turned bearish (see “Dow Theory Flashes Sell Signal”).
This earnings season, we have witnessed disappointing earnings from large multinational companies.
To add to the misery, other Dow Jones Industrial Average companies, such as Caterpillar Inc. (NYSE/CAT), General Electric Company (NYSE/GE), McDonalds Corporation (NYSE/MCD), and International Business Machines Corporation (NYSE/IBM), are raising questions about future expectation.
International Business Machines (IBM) saw its revenue decreased in the third quarter, saying the government and businesses are very carefully watching their spending. (Source: The Wall Street Journal, October 29, 2012.) Caterpillar and General Electric (GE) are also warning of softening demand for their products.
But before the Dow Jones Industrial Average companies started warning about earnings, the Dow Jones Transportation Index had already tanked.
Below is the chart of the Dow Jones Transportation Index. The index hasn’t achieved a lot in 2012.
Chart courtesy of www.StockCharts.com
On the other hand, the Dow Jones Industrial Average has had a banner year, until recently.
What does this all mean? Are the trends changing and are the markets reversing? Yes, I believe this is exactly what is happening. We are seeing a huge reversal in the direction of the Dow Jones Industrial Average; a “reversion to the mean” as they say.
If you follow the Dow Theory, the recent weakness in the Dow Jones Industrial Average, with the Dow Jones Transportation Index having deteriorated for months, shows a turning point in the markets.
I have been warning for weeks that the third-quarter earnings season would disappoint. Poor corporate earnings have been the catalyst for the weak performance of the Dow Jones Industrial Average. The right shoulder of a large head-and-shoulders pattern for the Dow Jones Industrial Average—very bearish for stocks—may now be complete.
Where the Market Stands; Where It’s Headed:
This week’s rut for the stock market has caused major technical damage for stocks. The bear market in stocks that started in March of 2009 may be just about over. I can just hear the cries for a fourth round of quantitative easing (QE4) starting.
What He Said:
“I see the coming recession being deep and difficult because U.S. consumers do not have the savings to spend their way out of the recession. The same thing happened in Japan. The Japan example proved that when consumer confidence is shattered, even zero percent interest won’t spur consumer spending. The same thing could happen here.” Michael Lombardi in Profit Confidential, August 23, 2006. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.