You may have heard John Hutchinson mention Dow Theory in one of his previous presentations. It’s a topic that comes up frequently in the Traders Reserve hallways. So, what is Dow Theory and why is it coming up yet again?
In simple terms, Dow Theory suggests the market is in an uptrend when either the Dow Industrials or Dow Transportation advance above a previous important high, and the other average confirms the move.
For example, the Dow Jones Industrial Average (DJIA) crosses above a previous high and the Dow Jones Transportation Average (DJTA) follows.
Let’s see how that looks.
Here’s a chart of the DJIA with a swing high from December.
And here is a chart of the Dow Jones Transportation Index.
When both indicators cross above their respective swing highs, the theory says the economy is strong.
Charles Dow developed the Dow Jones Industrial Average in 1896 and believed one could analyze the overall market and could accurately predict the direction individual stocks would take based on the overall economic picture.
The theory was based on the connection between transportation (think railroads back then) and manufacturing. If the core components of the Dow Jones Industrial Average were on the rise, they would need goods and services to be transported in or exported by the companies in the transportation index.
It made sense in the late 1800s, but the emphasis on transportation and railroads isn’t as important in the current service-based economy, especially when so much is “transported” digitally.
You can see from the charts above that the Dow Theory suggests the economy is neutral right now, but keep watching for the moment these two align and head higher. It often shows a strong economy and a push higher in the stock market.
Ok, now let’s take a look at the reports coming out this week that might help move the Dow Theory into bullish territory … or knock it down.
Tuesday – 10:00 am EST – Consumer Confidence
Tuesday – 10:00 am EST – New Home Sales – The forecast is showing 630k homes compared to the previous 640k. It’s not a surprise given where interest rates are and the fear of a recession.
Thursday – 8:30 am EST – Jobless Claims – The market is expecting to see jobless claims tick up from 245k last week to 249k this week. The Fed doesn’t want to see a collapse in the jobs market, but a rising unemployment rate could help the fight against inflation.
Friday – 9:45 am EST – Core PCE Price Index – This is the Fed’s primary inflation measure and last month the number came in below the forecast, with a 0.3% rise. The forecast for this month is to stay at 0.3%. While keeping the same as last month is positive, the Fed will want to see further drops before they start talking about lower interest rates.
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