To avoid glazing your eyes over, I won’t bury the lede: The “Dow Theory” buy signal was reconfirmed this week and that means the stock market is in great shape. I promise that I will keep this simple — and worth your while to read. However, we do have to go over just a few things.
First, Dow Theory is the creation of Charles Dow, a founder of The Wall Street Journal, who more than a century ago observed several recurring events in the market. And since I promised simplicity, I will only look at the part that most people know — that new highs in the Dow Jones Industrial Average and new highs in the Dow Jones Transportation Average simultaneously means that the market is firing on all burners.
If companies that make the goods and companies that move the goods to market do well then the economy theoretically does well. And by extension, the stock market should do well.
Got it? This week, the Transports finally joined the Industrials at all-time highs. That is a bullish sign in the Dow Jones today.
Click to EnlargeOf course, the Industrials have been making new highs fairly regularly since the election. The Transports broke out just after the election as well, and that was the true Dow Theory buy signal.
After months of consolidation in the Industrials, and an actual bear market in the Transports, both made big upside moves last November.
Since the market was already on a buy signal heading into this week we cannot have another buy signal. We need a sell signal first and that did not happen.
Click to EnlargeHowever, we can look at this positive price action as an affirmation of the buy signal that is already in place.
Not to mention that “new all-time highs” is not exactly bearish.
Why Every Investor Should Care
We can argue that the composition of each average is not a good representation of the current economy.
After all, out of 30 stocks, there are arguably only eight true industrials in the Dow Jones today. And in an information and service economy, communications stocks should probably join planes, trains and trucks in the Dow Transports.
But the idea that both averages should do well is more about market breadth than actual makers and movers. Not only did both averages reach new highs this week but so, too, did biotech, banks, semiconductors, defense, home builders, chemicals, small caps, micro caps, big caps and giant caps. The advance-decline line on the New York Stock Exchange is also reached record high ground. And even energy woke up after its private bear market.
You get the picture. The state of the market shows broad participation, rising trends and now a reconfirming Dow Theory buy signal.
Don’t believe Dow Theory just because two averages did well. Believe it as an indicator that the market is healthy, and barring any serious misfires in Washington over tax reform there should be plenty of life left in the bull.
As of this writing, Neil Martin did not hold a position in any of the aforementioned securities.