Through the years, stock market “gurus” come up with different market theories on how to forecast the direction of stock prices. As time goes by, most market forecasting theories are proven to be fallacies. There are only a handful of market theories I really believe in, the oldest and likely most important being the Dow Theory.
Under the Dow Theory, stocks will only advance to new highs if both the Dow Jones Industrial Average Index and the Dow Jones Transportation Index are moving together to new highs. The old theory holds that the big manufacturing companies in the popular Dow Jones Industrial Average are making the products and the big companies in the Dow Transportation are delivery those products to either wholesalers, distributors, or customers themselves. The products manufactured need to get to their buyer.
If we apply the Dow Theory model to today, we find it troublesome to see that while the Dow Jones Transportation Index has moved to higher and higher levels over the past couple years (recently breaking to consecutive new highs), the Dow Jones Industrial Average has failed to confirm the advance of the Transports (as they’re often called).
This blatant non-confirmation of an old theory I still believe in has been bothering me for several years now. While the Dow Transports continue to move to new record highs, the Dow Jones Industrial Average has failed to surpass its record high–a high achieved a six years ago.
A current theory on the Dow Theory (gee, what a pun) making the rounds is that the companies in the Dow Jones Transportation Index are busy delivering products made in China and that’s why stocks in the Dow Jones Transportation Index are doing so well. Who knows? Could be true.
But the bottom line for me is that until both the Dow Jones Industrial Average and the Dow Jones Transportation move in tandem to new records highs, I can’t take the recent strength in the marker seriously. In fact, with the higher interest rates we are now facing, I believe the lack of confirmation by the two popular indices could actually be flashing a cautionary sign.