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Is the Dow Theory turning bullish?

A deeply inverted yield curve, continued rate hikes by the Fed, geopolitical uncertainties in Europe and Asia, slowing GDP data from China, persistent global inflationary pressures, recession concerns, second-quarter corporate earnings, commercial and regional banking uncertainties, and other issues have many investors fearful of another market sell-off.


Although there may still be storm clouds on the horizon, the Dow Theory, which dates back to the 20th century, has flashed a potential buy signal.


The Dow Jones Industrial Average (INDU) recorded a higher high and a fresh 52-week high today (7/18/23), finishing at 34,585.35. INDU’s sister average, the Dow Jones Transportation Average (16,142.30), consisting of 20 stocks in the airlines, delivery/logistics services, and railroads, also recorded higher highs and new 52-week highs last week on 7/10/23, above 15,533.38/15,640.70 (5/4/22 and 2/2/23 highs).


Since the 1950s, the US economy has been predominately a service economy, and, as such, the S&P 500 Index and the Nasdaq Composite Index are better proxies of today’s US economy. Around 77% of the US GDP is in the services sector.


Nonetheless, the Dow Theory buy signal is the first bullish signal from the two major stock market indexes over a 1-year timeframe. The recent Dow Theory buy signal suggests the stock market may be broadening outside the mega-cap technology names. Improving or expanding market breadth remains one of the critical factors to a sustainable longer-term stock market rally.


INDU and TRAN may be far from all-time highs, but the recent technical actions bode well for at least a catchup play to the benchmark SPX Index and the technology-laden Nasdaq Composite and Nasdaq 100 Indexes. Also, because the industrials and transportation sectors are economically sensitive to business cycles, strengths in these markets suggest the stock market is anticipating a soft landing or a mild recession rather than a hard landing or a severe recession. If the small and mid-cap stocks also begin to participate in the stock market rally, this would further broaden the breadth of the marketplace.


On the charts, the Dow Jones Industrial Average (INDU - 34,951.93) has yet to establish a new record high above 36,799.65 (1/4/22 closing all-time high). However, it has recently recorded a 52-week high above 34,589.77 (11/30/22 closing high). The Jan 2022 downtrend break out last November 2022, and the recent neckline breakout above 34,152-34,590 is bullish. Confirmed breakouts suggest +2,800/5,900 points or a retest of the record high (36,799.65 - 1/4/22) and above 37,400 (h/s bottom breakout projection, intermediate-term) and 40,500 (longer-term). Key initial support is 34,152-34,590 (7/18/23 breakout) and below 33,715-33,761 (6/26 and 7/7/23 lows and 50-day ma), 33,440 (Mar/May 2023 uptrend), and 33,138 (200-day ma).


Dow Jones Transportation Average (TRAN - 16,142.30) has lagged the Dow Industrials Average (INDU). However, this is no longer the case, as evidenced by the 7/7/23 breakout above 15,533-15,641 (May 2022 and Feb 2023 highs) and the Nov 2021 downtrend breakout above 15,791 (7/10/23). The two favorable developments confirm an intermediate-term trend reversal and a new 52-week closing high. The break out suggests +2,342/3,641 points or TRAN targets toward 17,039.38 (Nov 2021 all-time high) and above 17,983 (intermediate-term) and 19,282 (longer-term). Initial support rises to 15,533-15,641 (early Jul 2023 breakout) and below 15,210 (Feb 2023 breakout), and 14,623-14,649 (late-Jan 2023 breakout).


In summary, if TRAN reaffirms higher highs via new 52-week highs and INDU also records higher highs via new 52-week highs, implying both markets are trading in sympathy with each other, either recovering or new bull trends. Since the breakouts to new 52-week highs recently occurred (i.e., INDU on 7/18/23 and TRAN on 7/7/23), it is crucial to monitor the days and weeks after the breakout for follow-throughs to these breakouts to confirm that these are valid and not false breakouts or bull traps.


Source: Chart courtesy of StockCharts.com

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