2017 Bulls Have Dow Theory On Their Side

For those of you raving about the stellar market showing in 2016, it might not be over yet. Brace for more upside, as the Dow Theory suggests the bull run has further legs to play out in the New Year.

Bull Run

The Dow Jones Industrial Average, the S&P 500and the NASDAQ are up 13.7 percent, 10.1 percent and 8.5 percent, respectively, in the year-to-date period. Even as skeptics have raised alarm over a correction, a century-old theory that has stood the test of time says otherwise.

The Dow Theory

When the Dow theory Dow Jones Transportation Average move in tandem with each other, it's a signal confirming the trend. The original theory propounded by Charles Dow had used rails instead of transportation stocks.

Although Dow neither named it nor presented it as a theory, William Peter Hamilton, Robert Rhea and George Schaefer put forward the theory based on Dow's editorial. Incidentally, Dow founded and edited the Wall Street Journal and he was the co-founder of the Dow Jones and Company, the firm behind the compilation of the Dow Jones indexes.

If the performances of the Dow Jones Industrials and the Dow Jones Transportation Average diverge, then investors be warned that a trend reversal may be in the cards.

The Logic

Those days, the Dow Jones Industrials heavily weight with manufacturing stocks. If the index is doing well, it's a sign manufacturing companies are faring well – meaning they're growing their top and bottom line. If the manufacturing companies are doing well and producing more, it logically follows that the goods produced have to be transported, potentially benefiting transportation companies. This reflects as better performance of the Dow Jones Transportation Average as well.

Naysayers Exist

The Dow Jones Transportation Index now includes airlines too, which are often used for transporting passengers and not goods. Similarly, the Dow Jones Industrial Average has technology stocks that sway the index. There is also an argument that most products are now downloadable over the Internet and not shipped.

The theory is also caned for not helping to identify the trend before it's too late.

The DJI-DJT Move of 2016

Compared to the nearly 14 percent gain of the Dow Jones Industrial Average, the Dow Jones Transportation Average is up about 21 percent in the year-to-date period. On December 8, the latter hit an all-time closing high of 9,421. Since then, the index has pulled back. Meanwhile, the Dow Industrials came within striking distance of 20,000, closing at a record high of 19,975 on December 20.

In December alone, the Dow Industrials are up 3.6 percent and the Dow Transportation has risen 1.2 percent.

Thus, the DJI-DJT move is seen as confirmation of the uptrend, with the two averages breaking to new highs in December and trading off these levels. Going by the good old Dow theory, it could be party time for the markets yet again in 2017.