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OT Dow Theorists smile after Friday rally

By Mark Hulbert, MarketWatch
Last Update: 4:20 PM ET March 4, 2005
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ANNANDALE, Va. (MarketWatch) -- Dow Theorists are breathing easier after Friday's rally, in which both the Dow Jones Industrial Average and the Dow Jones Transportation Average closed above previous recent closing highs set in late December.

The Dow Theory, of course, is the oldest market-timing system still in widespread use. Though its adherents do not always agree on all aspects of their interpretations, the Theory's general outline is clear enough: A bull market is confirmed when both the Dow industrials ($INDU: news, chart, profile) and the Dow transports ($TRAN: news, chart, profile) jointly reach significant new highs, while a bear market is signaled when both averages reach significant new lows.

Market turning points occur when the two averages trend in opposite directions -- "nonconfirmations," in Dow Theory parlance.

It was the potential for just such a nonconfirmation that had many Dow Theorists worried over the last couple of months. After hitting new 52-week closing highs in late December -- 10,854.54 for the DJIA and 3,811.62 for the DJTA -- both averages had declined significantly in the new year. And even though the DJIA rallied strongly in February to within shouting distance of its December peak, the DJTA remained far below its late-2004 level.

Many grew resigned to the possibility that even if the DJIA were to eclipse its late-December levels, the DJTA would not -- a potentially bearish development.

But Friday's rally was even stronger for the DJTA than for the DJIA, and now both averages are above their late-December levels.

Does this mean that Dow Theorists are unanimous in believing that happy days are here again?



The answer: yes, at least for the short term, according to the three investment newsletters I monitor that base their market timing on the Dow Theory: Dow Theory Letters, edited by Richard Russell; Dow Theory Forecasts, edited by Richard Moroney; and TheDowTheory.com, edited by Jack Schannep.

However, Russell remains bearish for the longer term. That's because, by his reading, the original Dow Theorists placed even more weight on valuations than they did on joint new highs among the primary Dow averages. And because the market remains overvalued according to any of a number of fundamental criteria, Russell believes that any bull market we are seeing now comes within the context of a secular bear market that will eventually take the market down to much lower levels.

But that could take many years to play itself out. In the meantime, and at least for the short term, the Dow Theorists are smiling.