Dow Theory is one of the oldest forms of technical market
analysis. The theory was originally devised by Charles Dow,
founder of the Wall Street Journal, over 100 years
ago. While there are six major tenets of the Dow Theory, the most
famous one states that both the Dow Jones Industrials and the Dow Jones
Transportation Average must confirm each other in order for a bull market to
Many analysts utilize Dow Theory in an attempt to forecast the
economy. Although one of Dow Theorys six major
tenets states that the averages discount the business outlook, the theory isnt always the crystal ball that
many of its adherents believe it to be. For instance, an extended rally in the Dow
Transports doesnt always
forecast a rosy economy. There
are times when movements in the Transports can be quite deceptive.
One of those times occurred in 2007 just prior to the credit
crisis. The Transports made a new all-time high in July 2007,
prompting many analysts to proclaim that the economic outlook was stronger
than it appeared at the time. That prediction failed, of course,
as the U.S. economy went into recession just five months later.
The Dow Transports have made yet another new all-time high as of
Tuesday, Jan. 22, producing once again a litany of bullish economic
forecasts. One respected analyst for a well
known brokerage firm went so far as to say, Ladies
and gentlemen, for the economically sensitive Trannies to do this speaks
loudly to my premise that there will be no recession in 2013.
Based on my experience, this is a premature statement at
best. A lot can happen between now and year-end, especially in
view of what happened in the parallel year of 2007. The long-term
yearly Kress cycle outlook tells us to maintain a cautious approach as we
head further into 2013 and especially as we approach 2014.
One instance of when the Dow Theory can be used as an economic
barometer occurs when the economy is weak and government statistics show
contraction month after month. If the Dow Industrials and
Transports begin moving higher in synch over a period of several
weeks-to-months in the face of economic weakness, it will almost certainly
portend a stronger economy down the road. Conversely, when the
economy is strong and the Industrials and Transports are weakening, the
implication is that the economy will follow suit.
A more likely explanation for the new high in the Dow Transports is
that it has resulted from Wall Street fund managers being behind the
proverbial eight ball entering the New Year. Hot money
inflows can lift equity prices irrespective of economic factors for weeks and
sometimes even months at a time.
The lesson of 2007 is not to let Wall Streets
hype of the new all-time high in the Transports lead to excessive greed and
blithe optimism about the economic outlook. As 2007 taught us, even the rosiest economic outlook
can quickly fall apart with the right catalyst.
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The new book explains that the
credit crisis of 2008 was merely the prelude in an intensifying global credit
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Clif Droke is the editor of
Gold & Silver Stock Report, published each Tuesday and Thursday. He
is also the author of numerous books, including most recently, 2014:Americas
Date With Destiny. For more information visitwww.clifdroke.com