Dow Theory believers see dark days ahead
By JERRY HEASTER - Columnist
Date: 08/15/98 22:15
While an emerging Wall Street consensus holds it will take a massive
sell-off before the stock market can regain the high ground of last
month's record highs, that day may be further away than many on Main
Street appreciate.
A fairly important but relatively unheralded development took place
recently that portends a prolonged period of sluggishness, if not
sustained bear market decline.
The event was the Dow Theory's bearish turn for the first time in more
than seven years. Although Dow Theory is viewed as a quaint artifact in some circles, its devotees contend that investors ignore it at their own peril.
When Dow Theory Forecasts recently alerted its clients of the bearish
turn, it noted that the Hulbert Financial Digest rates its market-timing performance of the last 15 years second best of all the advisory newsletters monitored by Hulbert.
Dow Theory is a technical analysis tool with a 100-year-old forecasting record that has allowed its followers to avoid the worst of the most devastating bear markets of the 20th century. Its origins derive from the belief that the Dow Jones transportation stocks must validate the performance of the Dow Jones industrials.
While sophisticates claim this approach is outmoded, Dow theorists
respond by pointing out that today's transportation average companies
are still highly sensitive to variables that move the market -- interest rates, labor costs, energy prices and consumer confidence.
Dow Theory signaled its latest warning sign recently, Forecasts said,
when Dow Jones industrial average of 30 blue-chip stocks slipped under
its June low of 8,628. From this bottom, the industrials and Dow Jones
transportation average rallied in tandem for more than a month. Only the industrials, however, made a new high, and the transportation average's failure to do likewise "represented a classic nonconfirmation."
To make things worse, the transport average's retreat brought it below
its June low of 3,259 for another significant development, according to Dow Theory. The transports' new lows reversed a three-year trend of
higher highs and higher lows.
This development didn't happen in a vacuum, either. The broader market
also has been flashing yellow as the breadth of its advance narrowed.
The Big Board's advance-decline line recently hit a nine-month low, Dow Theory Forecasts noted, while the average New York Stock Exchange stock is trading 25 percent below its 52-week high.
This sort of deterioration, in fact, has extended far beyond the
big-capitalization stocks, which Market Logic recently discussed in the context of the Russell 2000 index's decline. This is significant because its 2,000 stocks are those of middle-size and small-capitalization companies held by many individual investors and equity mutual funds.
Moreover, as Market Logic observed, "a cardinal rule of technical
analysis is that a disparity in which the broad mass of stocks is weaker than the blue chips is more often than not followed be weakness across the board."
In other words, this market has a whole lot more going against it than
many casual observers have noticed just from following the Dow
industrials and the S&P 500. Thus, the gains posted through mid-July by the most popular averages were masking market malaise that has been
developing over a prolonged period but has been largely overlooked. |
