The State Of The Dow Theory


For users of the Dow Theory, this year's market action can be summarized thusly:

• On Jan. 20, the bearish primary trend was reconfirmed when the Dow Industrials closed at 15,766.74 and the Dow Transports closed at 6,625.53 — their lowest levels in more than a year.

• From Jan. 20 to Jan. 29, the Industrials rallied 4.4% to 16,466.30. The Transports gained 6.4% to reach 7,051.25 on Feb. 4.

• Both averages then pulled back to Feb. 11, with the Industrials retreating 4.9% to reach a fresh low of 15,660.18. But the Transports dipped only 2.4% to reach 6,883.49 on Feb. 11.

• Since Feb. 11, both averages have gained more than 5%.

From a Dow Theory perspective, we see two ways to view this year's market action:

1) The Transports staged a meaningful advance, then held above a significant low when the Industrials went to a new low on Feb. 11. When fresh lows in one average are not confirmed by the other, it signals a possible change in trend — if both averages then rebound above significant highs.

Under this interpretation, with the Transports having closed above their Feb. 4 high, all that's needed for a bull-market signal is a close above 16,466.30 in the Industrials.

2) The Transports bottomed on Jan. 20, while the Industrials did not bottom until Feb. 11. Those points — 6,625.53 and 15,660.18 — represent the key lows. For a return to the bullish camp, three things must happen. First, both averages need to stage significant advances from those lows. Second, both averages must suffer meaningful pullbacks without new lows in both averages. Third, both averages need to rebound above the highs established in the rebound from the lows.

Under this interpretation, all that's occurred so far is a significant advance in the Transports, along with a 5.1% rally in the Industrials over three trading days.


We see No. 2 as the more plausible interpretation. For one thing, the Transports only dipped 2.4% from Feb. 4 to Feb. 11, so it makes sense to view the entire move since Jan. 20 as one rally. For another, in both averages the pullbacks to Feb. 11 lasted well short of three weeks, which Dow Theorists traditionally use as the minimum for a significant correction.

While we'd view a close above 16,466.30 as a near-term positive — and perhaps as a reason to put some cash to work — we are likely to maintain a defensive posture until the averages provide a definitive bull-market signal. Still, we continue to look for opportunities, and the cash positions of our buy lists are being cut to 18.1% to 21.2% because of this week's additions of Amerco ($344; UHAL) and Biogen ($266; BIIB).

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