Putting Dow Theory to the test
The Dow Jones Transportation Average (DJT) has surged roughly 10% over the past month, leaving it less than half a percent below its all-time high set in November 2024. Under Dow Theory, that should bode well for the broader stock market.
A core tenet of Dow Theory is that the DJT should confirm the stock market trend. In other words, when the Dow Jones Industrial Average (DJI) is reaching new highs, the DJT (which ships goods the DJI makes) should be hitting new highs as well. Otherwise, you wouldn’t be able to trust the trend. In this article, I’ll dig into the historical data to see if the numbers support that claim.
Crunching the Data
Before testing the core principle of Dow Theory, I analyzed DJI returns since 1950. The first table is a good benchmark, as it displays the Dow’s returns for timeframes varying from a month to a year. The second table summarizes returns when the index is within 1% of an all-time high. It shows slight underperformance for the one-month timeframe when the index is high, though after that returns are similar, with a bit less volatility according to the standard deviation of returns.
I ran the same analysis on the DJT that I did on the DJI. The first table shows the DJT’S returns since 1950, while the second table displays returns when the DJT was within 1% of its all-time high.
Unlike the DJI, there’s a big difference between the two tables. When the DJT is near a record high, it drastically underperforms compared to its typical behavior. Over the next year, the DJT’s average return has been about 10%, with gains 66% of the time. When the index was within 1% of its all-time high, however, the average return fell to just 2.55%, with only 53% of those returns positive.
Testing Dow Theory
Now, let’s look at how those indexes have performed when both the DJI and DJT are within 1% of record highs. Based on Dow Theory, this should confirm the trend of the general stock market, but that is not the case.
We noted earlier that when the DJI is within 1% of its record high, without considering the DJT, it returns on average 8.07% in the next year, with 72% of those return positive. When the DJI and DJT are within 1% of those highs simultaneously, the DJI averages a return of 6.17% over the next year, with 66% of the returns positive. Meanwhile, the DJT averages a return of just 2.43% over the next year.