The funny thing about the stock market is that there are so many different indicators out there. In fact, they are a dime a dozen. These indicators tell you when to buy. They tell you when the market is near bottom. They tell you when to buy or sell commodities. They have many indications for a wide range of suggested actions.
The Dow Theory is just one of these theories. What sets it apart is that it has historically been accurate. This is what makes it both interesting and scary.
What is the Dow Theory? The Dow Theory was actually formulated by an editor of the Wall Street Journal over an extended period of time. This is supported by actual market performance and data. Still, it is a theory; it is not a fact. Take this with a grain of salt.
How does it work? The Dow Theory indicates that it is time to sell your stocks if the following signals all take place. First, both the Dow Jones industrial average and the transportation index must post a significant correction. We are talking about a steep fall in equities prices in both these indices. Second, either or both indices register a recovery, but it isn’t high enough to make up for their correction. Finally, either or both indices drop to a lower level below their correction lows.
According to its recent performance, the Dow Jones transportation index has exhibited these patterns. The Dow Jones industrial average also got beaten up. Put these together and the Dow Theory is saying that now is the time to get out of the market.
With that said, the market continues its yo-yo pattern. It would sink and then it would have a rally that takes it closer to another record. In fact, if you look back since this past September when there was a 10% correction, the market then proceeded to rally to hit record levels. What is going on? What accounts for this erratic behavior if the Dow Theory is such a solid-clad indicator of impending financial doom?
If you want a short and obvious answer, here it is: cheap stimulus money. That is all there is to it. The reality is that the Bank of Japan is printing up money. The European central bank is cranking out cash. And stateside, we are still dealing with the hangover effect of the huge amount of liquidity unleashed by the Federal Reserve. Put all these together and you see an equities market that is simply drunk off cheap liquidity.
It is only going to be a matter of time until all that cheap stimulus money dries up or provokes unintended consequences which may or may not include a nasty correction. Still, there should be no doubt that there is some sort of bubble-like dynamics in play in the global equities market.