In the late 19th century, Charles Dow, editor of the Wall Street Journal, devised the fundamental basis of what would become the Dow Theory. In essence, the theory stipulated that the market was confirmed to be in an upward trend when one of its’ averages move above a previous significant high was done in tandem with another average. Conversely, downward trends would be confirmed by an average breaking through significant lows and also being accompanied by another average doing the same.
In Charles Dow’s time, the rail system was the veins and arteries through which the economy’s life blood was provided. Just like an individual with a clogged artery, for example, is predisposed to heart problems, Dow saw that the Rail Average could be a preliminary signal for the Industrial Average. It was for this reason that Dow employed the Rail Average as a valid confirmation of the Industrial Average’s overall directional trend. Today, the Rail Average has given way to the Dow Jones Transport Average (DJTA), an index which includes not only the rails companies, but trucking, airlines, and other transport companies.
So where does the Dow Theory stand today, as 2006 comes to a close? The Dow Jones Industrial Average (DJIA) has certainly shown its vivacity in breaking through high after new high. The question Charles Dow would ask is: “Is this upward trend confirmed?” The answer lies in an examination of the following graphs:
The above shows us something very troubling. While the DJIA is pushing through new highs since its previous peak in May, the DJTA has not confirmed this upward movement by breaking its old high. This alone is problematic enough; however, the DJTA seems to be completing a head-and-shoulders top pattern that could be putting it in an unconfirmed downward trend.
Investors should be astute and observe the markets closely in the coming New Year. There are two possibilities to look out for:
1. The DJTA breaks its May high and confirms the DJIA’s bull trend, or
2. The DJIA falls below its May high support, and the DJTA continues its bearish trend that began in mid November.
Although one might hope for the prior, it would be of this author’s opinion that if Charles Dow were still around, he would probably not be very optimistic about the Industrial Index’s current situation.
Wishing you a Merry Christmas!
See you next Tuesday.
