An Alternative Dow Theory
"The conflict between the men who make and the men who report the news is as old as time. News may be true, but it is not truth, and reporters and officials seldom see it the same way. In the old days, the reporters or couriers of bad news were often put to the gallows; now they are given the Pulitzer Prize, but the conflict goes on." - James Reston 1909-1995, Dutch Born American Journalist
Let's start of by looking at some old long term charts of the Dow transports, utilities and Industrials to see what they might be revealing. The main relationship appears to exist between the Dow and the transports but the utilities appear to play an important part also. The 1st chart is of the transports, the second of the Dow industrials and the third of the Utilities.
This chart starts from 1969 and carries on to November 1981. If we go three years back to 1966 we see that the Utilities were the first ones to put a high back in 1966 after that they just kept testing the highs (looks like a triple top). The Transports put in a new high around the middle of 1967 and then sort of trended sideways. The industrials only put in a new high towards the end of 1969 and then started correcting. The charts below show that all 3 proceeded to correct around the same time but they topped at different times. As we stated before there is a relationship between all 3 though the utilities seem to interact with the other two best around market bottoms and not so well at market tops. The industrials and the transports mounted what appeared be a hard correction and bottomed around the middle of 1970. The utilities on the other hand did not correct so hard and even though they rallied after bottoming they never put in new highs but traded sideways from 1971-1973 indicating that a more severe correction was in the works. Let's just stop here for a second and now look at what the Dow and the transports did after correcting and bottoming in the middle of 1970. Once again the transports led the way up and put in new highs almost a year before the Industrials. The transports started to correct as the Dow was in the process of putting new highs once again showing that it leads the Dow both during advances and corrections.
As we stated before the utilities work well with the other two in predicting market bottoms. Note that unlike the Industrials (Dow) and the transports the utilities just traded sideways and it actually started to correct around the same time the Dow was putting in a new high. Then the correction picked up steam which resulted in both the Dow and the Utilities putting in what was a new 13 year low. Note though how the Transports actually put in a higher low indicating that another bullish run was in the works. The bullish pattern is best illustrated by the Transports and the bearish pattern best by the utilities. Look how the transports went on to put in 3 new highs (one in the beginning of 80, one towards the end of 80 and one in 81) while the Dow and the utilities basically traded sideways building energy for the next leg up. We have always stated that the longer the channel formation the powerful the final move is. Look at how both the Dow and the Utilities exploded to the upside; look at the charts below that cover the time period from 1976-1986.
When the Dow finally broke out of the channel formation around Oct of 1983 it went ballistic; it gained close to 90% in 3 years. The utilities also rallied rather hard and also gained over 90% in the same time frame. We are not going to look at the transports but they continued to rally and went on to put in several new highs from 1981-1986. What we are looking for is a relationship and trigger points.
So far we can conclude that the transports seem to have the best relationship with the Dow but not in the way the Dow theorists would have you believe. The Transports top way in advance of the Dow, the utilities serve as a collaborating agent; if they do not confirm the highs it appears that a more severe correction is in the works. This was the case when the Transports put in new highs in 1972 and the Dow followed in 1973 but the utilities did not follow through.
The difference between this era and the current era are several
- The number of overall players was much smaller
- Volume was much lighter. The number of shares that trade in one day now could be equivalent to one months of trading volume back in the 70's.
- There are no longer any barriers to the US markets; outside players are able to access it just as easily as local players
- The age of the internet also means that the markets are now within the reach of the big, medium, and very small players. In fact everything is just a mouse click away.
Moves that would take years to complete now only take months and those that took months only take weeks. This has another side effect and that is that volatility has gone up by a factor of 1000. We have already demonstrated that on the shorter time frames a relationship existed between these 3 exist and now we have also confirmed that there appears to be a very old long term relationship in place too.
So let's fast forward to now and see what these 3 are saying.
Lets start of with the utilities they once again seem to serve the function of collaborating a move; in other words if they move in different direction to the others it means the Dow and the Transports will have to play catch up. Note that the Utilities have been in a super uptrend for the last 3 years while the Dow and transports did nothing for 12 months and 15 plus months respectively. The Transports were locked in a tight channel formation from Nov 05 to Nov 06 while the Dow was locked in the same position from Nov 05 to about Feb 06. The utilities continued to move upwards while these two did nothing and this meant that sooner or later the Dow and the transports would play catch up and catch up they did. Note as expected the Transports broke out earlier (Nov 06) and 3 months later the Dow followed. Then just like the 1972 and 73 era as the transports and the Dow broke out the Utilities started to mount a hard correction (go back and look at the first 3 graphs and look how eerily similar they look). Once again the Transports lead the Dow and put in new all time highs first and about 4 months later the Dow went on to put in a new all time high. Note while this was going on the Utilities were moving in a tight channel and have just recently broken out. The 1st chart below is of the Dow, 2nd of the Transports and the 3rd is of the Dow utilities.
Now this is the hard part trying to make sense of so much data and all the different patterns and then to present this info in an easy to digest and understandable format.
All charts were provided courtesy of www.prophetfinance.com.
All 3 are still in an uptrend. The Utilities appear to have broken out of a channel, appear is the key word here as it could be just a false break out. One important thing is that they did put in another all time new high and if they were to correct now they would flash several negative divergences. Since the utilities lead this means that the Dow and transports should follow by putting in a new high after correcting. If they follow the same pattern that means this correction is going to be hard and fast. Look at how fast the Utilities corrected after putting a new high back in Oct 2005. In less then one month they dropped from 440 to 380; a pretty significant correction. To be precise it corrected 13.66% in that one month and then moved sideways till August where it tested its old highs and then finally broke into new ground.
As the transports lead the Dow it appears that the transports have already mounted this correction. They started to correct in July a full 9 months after the utilities; actually one could state that they started to correct in May but then proceeded to put in a double top in July. From a high of roughly 4950 they corrected all the way down to 4140 a whopping 16.36% correction. They are now slowly moving higher but have yet to put in another new all time high. As they lag the Utilities by several months we think that the new high is still in the making. This means that the Dow is now ripe for a correction after having finally put in series of all time new highs. Thus if this old pattern is true and it appears that it is a rather significant pattern then both the transports and the Dow industrials should rally to put in a new set of highs. The Dow however still needs to mount a nice decent correction before it can embark on the next leg up.
We started this thinking it would be a simple exercise but it's truly amazing how much info we are able to pull out of a few charts and how when you look for patterns you start to see things that most people will miss even though it's right under their nose.
Further down we have examined 36 different markets and the info we have obtained from those charts appear to provide even more ammunition to the theory above. All the Major world markets are sort of behaving like the Utilities in that they have put in new highs way before the Dow then they corrected and now they have put in a new set of highs. The pull backs ranged from a low of 7% to a whopping 23% correction. Note also the NYSE which is another leader in the US Markets has also gone to put a new high but if it were to correct soon it would flash massive negative divergence signals. As it's a leader it usually makes a move several months before the other indices.
This is what we think will happen. The Dow is going to correct the longer it takes to correct the more severe the correction is going to be. Then it's going to trade sideways for a bit while it's doing this we will have to pay attention to the Transports to see if they go on to put a new set of highs; if they do then it means the Dow will follow. If they don't we will use our other indicators to guide us. However we suspect that they will follow the pattern the utilities have displayed.
We also think that the next series of highs are going to take place while several massive negative divergence signals are flashed. To confirm that a massive correction is the works our psychological indicators should start flashing sell signals (which we are sure they will), our technical indicators should do the same also and the NYSE specialists should start to load up on shorts. If this happens then it will be time to for the most part close almost all our longs with the intention of buying twice as much of the same companies when the markets start to bottom or the relevant sectors start to flash new buy signals on the daily charts. This entire chain of events could take as much as another 12 months to unfold so we would not flee for the exits yet. What do we mean by the entire chain of events? The Dow correcting, then trading sideways and then proceeding to put in a new set of all time highs; along the way we will be monitoring the Dow transports to see what they do. Now if things work out as stated above it would generate what we would like to term the perfect sequence for taking a massive short position; such sequences do not manifest themselves often; jumping in too early could be disastrous and rather painful. As always timing is everything. In a follow up article next year we will post our new targets for the Dow; in 2003 well before anyone was even that bullish we posted targets for the Dow and all of them were hit and surpassed Full Article. Then on March 15, 2005 we stated that the Dow could trade in the 12200-12500 ranges Full Article.
"To know yet to think that one does not know is best; Not to know yet to think that one knows will lead to difficulty." Lao-Tzu BC 600-? Chinese Philosopher, Founder of Taoism, Author of the "Tao Te Ching"