When shipping companies sink, so does the market. That's one premise behind a popular technical study known as Dow Theory.
When shipping companies sink, so does the market. That’s one premise behind a popular technical study known as Dow Theory. It says that the 20 stocks in the Dow Jones transportation average either set the pace or “confirm” the direction of the broader market. They can thus predict more pain, or gains.
Dow Theory proved reliable Sept. 29 when the transports fell below their July low, confirming an earlier such move by the industrials. Sure enough, on Oct. 27, the Dow industrials hit a new bottom of 8,175.77. October was the worst month for the industrials in 21 years.
Analysts are waiting to see if at least one of the averages stays above its October low, says Richard Moroney, editor of Dow Theory Forecasts. If one or both can recover at least one-third of their recent decline and maintain it for several weeks, it could be viewed as a bullish signal, he says.
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The logic behind Dow Theory is fairly simple: Manufacturing and shipping companies tend to be linked, so when each group achieves a high or low, the other is likely to follow. When they diverge, on the other hand, it may signal a market reversal. The theory originated with Charles Dow, the creator of the Dow industrials and founder of The Wall Street Journal.
Markets are much more diverse today than when Dow Theory originated, Moroney says, so it shouldn’t serve as a gauge for any single stock. Besides, even if the bear market lingers, he sees great buys in many stocks. However, he says, “the market is usually right, and there’s a lot of validity in (the theory). It’s definitely a tool you want in your toolbox.”