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Dow Theory Predicts Correction

A hundred year old stock market predictor has investors worried. The Wall Street Journal reports that Dow Theory is indicating a market correction. It has to do with surging industrials and lagging transportation stocks.

Warning signals from a century-old stock-market analysis tool known as Dow Theory are sparking debate about whether stocks are headed for a fall.

Dow Theory holds that any lasting rally to new highs in the Dow Jones Industrial Average must be accompanied by a new high in the Dow Jones Transportation Average-the 20-stock index that tracks some of the largest U.S. airlines, railroads and trucking companies. When the transport average lags, it can presage broader stock declines.

The Dow transports are sitting on a 6.9% decline for the year. They haven’t hit an all-time high since Dec. 29. Delta Air Lines Inc. has dropped 13%, United Parcel Service Inc. 9.6% and railroad CSX Corp. 5%.

When business and industry are humming along they should be shipping products. The fact that transportation stocks are slumping indicates that perhaps the industrials are inflated. Thus the Dow Theory predicts a correction.

How Long Can a Rally Last (without a correction)?

While Dow Theory predicts a correction so does common sense. The market has gone up for four years with a ten percent pullback, the standard definition of a correction. Market Watch gives their opinion about June swoons as opposed to how Dow Theory predicts correction.

In 119 years that the Dow Jones Industrial Average DJIA, +1.44%  has been calculated, the Dow has risen in 63 Junes (53%) and fallen in 56. In the positive Junes the gains averaged 4.3%; in negative Junes declines averaged 3.4%.

The odds narrow a tad if just the “modern” era is considered. In the 69 Junes since the end of World War II, the Dow rose in 36 of them (52%) and fell in 33. The average gain in up years was 3.2% and the average decline in down years was 2.6%.

Despite the time honored advice to sell in May and go away, it turns out that stocks more often go up than down in May. So a weakening market right now is not the norm.

Long Overdue

CNN Money says that the stock market is long overdue for a big drop.

It has been 925 trading days since the stock market had a correction, according to a recent Deutsche Bank (DB) report. That’s more than double the average length of time it usually takes.

A correction is a 10% or greater decline in the stock market in a short period of time. The average rally period without a correction is 357 trading days, according to a Deutsche Bank analysis of stock market moves since the 1950s.

The Deutsche Bank strategists aren’t quite ready to say a correction is imminent, but they add their voices to those saying: Beware!

People are looking at various predictors to decide is the market is about to hiccup or not. While the Dow Theory predicts a correction so does the law of averages.

Dow Theory Predicts Correction PPT





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