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Dow Theory Gives Warning; Can the Fed 'Print Over' It?


Dow Theory warns of a trend change; but is this warning still valid in a market back-stopped by QE-Infinity?

MINYANVILLE ORIGINAL In this article, I'm going to discuss Dow Theory, the dollar, and inflation, and how they relate to the Federal Reserve in today's market.

Dow Theory views directional divergences between the Dow Jones Industrial Average (INDEXDJX:.DJI) and the Dow Jones Transportation Average (INDEXDJX:DJT) as important, and the two markets are diverging significantly right now.

There are six basic tenets behind Dow Theory but, for discussion purposes, the one we'll focus on today is the tenet that the market averages must confirm each other. As its name suggests, the Dow Jones Industrial Average is concerned primarily with industry, i.e. the production of goods, while the Transportation Average is more concerned with shipping those goods to market. The logic behind the theory is fairly simple: If the economy is improving, then economic production should be increasing (positive for INDU), which also means there will be more goods needing shipment (positive for TRAN). Logic tells us the reverse should also be true: less production should equal less demand for shipping. Thus the two averages would seem inexorably linked in an economic sense, and should generally be moving in the same direction.

According to Dow Theory, when the two indices diverge, it's a warning that a trend change may be brewing.

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Here's where things get a bit interesting...
No positions in stocks mentioned.
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