In our last discussion of Dow Theory on September 8, 2010, we indicated that the Dow Industrials and Dow Transports had formed a line. The line that we discussed in the September 8th article was broken through on the upside in the month of October. According to William Peter Hamilton, a line in the market could be considered as important as a market crash. We decided against a reaction on the line being broken to the upside out of concern for jumping the gun. To be conservative on the topic of Dow Theory, we opted for the sure fire signal of a continuation of the bull market trend with the markets making new highs above the April/May points.
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On November 3, 2010, the Dow Industrials (DIA) confirmed the Dow Transports (IYT) breach of the their respective highs since the 2009 bottom. The new high came on the news that the Federal Reserve is going to fully implement quantitative easing (QE2) to further boost the economy. In addition, the new high arrived as the results of the November 2nd election were finally in. We are not surprised of the coincidence of QE2 being introduced immediately after the election results. Our last article on the topic Dow Theory on September 8, 2010 closed with the following commentary:
Politicians vying for re-election will fight tooth-and-nail against outcomes that don’t ‘appear’ positive. With this in mind, it is possible that the only option is to the upside.
With this confirmation, we can only guess as to where the next stop for the markets might be. However, in our February 12, 2009 article we discuss the idea that when the stock market falls 40% or more there is the tendency to retrace 50%-100% of the prior decline. So far the Dow Industrials have retracted 61% of the previous decline from 14,164.53. With the introduction of QE2 at this point in the game, we’re likely to achieve 100% retracement of the market from the October 2007 top.
With a goal of self-preservation in mind, we have the tendency to believe that the market is always going to fall rather than head higher. This time is no different. However, the Dow Theory signal is telling us that as long as we don’t get a sudden reversal of the trend we’ve got at least another 3 to 9 months of an upward bias in the stock market and the economy. Our September 8th article said:
the length of time that has been spent in such a range seems to indicate that we’re due for a breakdown or an explosion if the markets cross below or above the range.
As a result of breaking about the line and the previous high, we may experience the oddity of a full-fledged financial stock panic to the upside regardless of whether it is warranted or not. Basically, this could be the final blow-off before attaining the cyclical bull market top.
Downside targets for the Dow Jones Industrial Average are:
Because we have a natural bias against the upside prospects, we caution all investors to pay close attention to the downside targets. All new investments should be with the acceptance that the Dow Industrials could fall to the 8,000 level without warning. However, facts being what they are, Dow Theory seems to be pointing the way for the economy and the stock market.
Disclosure: No positions