U.S. Stocks Have Further to Fall, Dow Theory Says (Update1)

By Elizabeth Stanton and Jeff Kearns
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Sept. 30 (Bloomberg) — Transportation stocks are signaling the market is poised for more losses after the Dow Jones Industrial Average posted its biggest-ever point decline.

Dow Theory, created by Wall Street Journal co-founder Charles Dow in 1884, holds that the 30-stock industrial average takes cues from the Dow Jones Transportation Average. The gauge of companies such as FedEx Corp. and Ryder Systems Inc. slid yesterday to the lowest since March 17, suggesting the industrials’ biggest point decline ever won’t mark its bottom, some investors say.

“When the Dow transports are making new lows, that generally signals more trouble for the markets,” said Frederic Dickson, who manages $17 billion as chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. “The transports are really a signal of what Wall Street thinks of overall economic prospects.”

According to Dow Theory, weakness or strength in manufacturing will last only if matched in the shipping of products. Until yesterday, when the transports joined the industrials in giving up gains since mid-July, that trend was bullish.

U.S. stocks tumbled yesterday after Congress rejected the Bush administration’s plan to buy toxic mortgages from banks. The Dow industrials plunged 7 percent to 10,365.45, while the transportation index tumbled 5.2 percent to 4,503.89. Shares rose today after lawmakers said they intend to salvage the $700 billion bank-rescue package. The Dow average rose 2.6 percent to 10,637.92 as of 10:16 a.m. in New York.

`Moving in Sync’

“Both indicators moving in sync to the downside is indicative of an economic issue that would translate into lower corporate earnings,” said Chuck Carlson, a money manager at Horizon Investment Services LLC in Hammond, Indiana. Horizon oversees $170 million and uses Dow Theory to determine how much cash to hold as insurance against declines in stock prices.

Companies in the S&P 500 are forecast to report a 3 percent drop in profits this quarter, the fourth consecutive decline, according to estimates compiled by Bloomberg. The benchmark index for U.S. equities lost 8.8 percent yesterday, the most since the crash of 1987.

Another indicator may show stocks are poised to rally. The VIX, as the Chicago Board Options Exchange Volatility Index is known, rose 34 percent to a record 46.72. The gauge, calculated from prices paid for options on the S&P 500, is considered the market’s “fear gauge” because it tends to rise as stocks fall.

VIX Peaks

Stocks usually advance after the VIX peaks, according to a note to clients by Bespoke Investment Group LLC, a research and money-management company based in Harrison, New York. After the 10 biggest percentage increases for the 18-year-old VIX, the S&P 500 added an average of 0.36 percent the next day and 0.5 percent during the next week, Bespoke analysts wrote.

Every company in the industrial average dropped yesterday as the measure slid to the lowest since October 2005. Nine companies fell to 52-week lows, including 3M Co., Caterpillar Inc. and United Technologies Corp.

Dow Theory’s last signal, on April 18, was bullish, as the industrial and transportation averages rebounded from declines in March. That changed yesterday as the transport gauge retreated for the fifth time in six days.

“People are anticipating that if the economy is slowing down people are going to be shipping less,” said Blake Howells, who helps oversee $2 billion at Portland, Oregon-based Becker Capital Management. “That would indicate that the market anticipates that the economy is going to slow.”

To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net.
Last Updated: September 30, 2008 10:19 EDT