‘Dow Theory’ Says Worst Isn’t Over for U.S. Stocks

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‘Dow Theory’ Says Worst Isn’t Over for U.S. Stocks as YRC Falls
By Eric Martin and Cristina Alesci

Feb. 21 (Bloomberg) -- A 125-year-old method for forecasting the market is telling investors the worst isn’t over for stocks.

Dow Theory, which holds that simultaneous moves in industrial and transportation shares foreshadow economic activity, indicates the Dow Jones Industrial Average’s drop to a six-year low yesterday may presage more losses.

The Dow industrials slumped to 7,365.67 on concern the deepening recession will force the U.S. government to bail out banks. Adherents of Dow Theory say the 30-stock gauge will fall farther because the Dow Jones Transportation Average has slipped to the worst level since September 2003.

“When you have that confirmation in both legs, that’s clearly negative,” said Ryan Detrick, senior technical analyst at Schaeffer’s Investment Research in Cincinnati. “There’s some validity to Dow Theory.”

This week’s retreat left the Standard & Poor’s 500 Index, the benchmark for U.S. stocks, within 2.3 percent of breaking through its Nov. 20 low to the worst level since 1997.

Citigroup Inc. and Bank of America Corp. declined the most in the Dow this week, losing more than 31 percent, on concern shareholders will be wiped out through nationaliGzation. General Motors Corp. had the third-biggest slump, losing 29 percent on concern about its solvency. General Electric Co. dropped 18 percent to $9.38, becoming the fifth stock in the average since last year to sink below $10.

“The direction of the market is clearly down,” said Richard Moroney, who manages $150 million at Hammond, Indiana- based Horizon Investment Services and edits the Dow Theory Forecasts newsletter. “We’re holding a lot more cash than we normally do.”

‘Clearly Down’

Dow Theory, created by Wall Street Journal co-founder Charles Dow in 1884, argues that transportation companies are harbingers of economic activity. The transportation gauge slipped below its November nadir in January and has kept retreating. YRC Worldwide Inc. and JetBlue Airways Corp. fell the most this week, losing more than 27 percent.

Dow Theory is showing that “the bear market is in force,” said Philip Roth, the New York-based chief technical analyst at Miller Tabak & Co. “It doesn’t tell you whether it’s going to last another year or another day. It isn’t a forecaster of magnitude, just direction.”

In November 2007, one month after the Dow industrials and S&P 500 surged to record highs, Dow Theory suggested the rally was over. The S&P 500 went on to tumble 38 percent in 2008, the most since 1937.

Bullish Strategists

The Dow Theory signal goes against all 10 Wall Street strategists tracked by Bloomberg, who on average project the S&P 500 will end the year at 1,059, a 38 percent gain from yesterday’s close of 770.05. Almost $800 billion in federal spending and the cheapest valuations in two decades will spur the rally, the strategists say.

The S&P 500 is a better indicator of the market’s direction because it has almost 17 times more companies than the Dow average and uses market value, not share prices, to determine company weightings, said Roger Volz, New York-based senior vice president at Hampton Securities Ltd. and a technical analyst since 1982.

The index would probably plunge to 681 should it fall below the 11-year-low of 752.44 reached in November, according to Volz. His chart-based techniques include Fibonacci analysis.

“I don’t think we get out of the woods for 14 months,” he said. “The destruction is severe.”

To contact the reporters on this story: Cristina Alesci in New York at calesci2@bloomberg.net; Eric Martin in New York at emartin21@bloomberg.net.