The century-old Dow Theory sounds the alarm, and the US stock market may face a larger decline

The century-old Dow Theory has issued a warning signal, indicating that battered investors may face more pain.

The theory posits that the movements of the Dow Jones Industrial Average and the Dow Jones Transportation Average need to confirm each other. In recent days, concerns over the economy and the Trump administration's aggressive tariff policies have intensified, leading to a severe blow to the stock market.

As of Thursday's close, the Dow Jones Transportation Average (a key indicator of consumer and industrial demand) has fallen 19% from its peak in November, nearing bear market territory. Combined with the 9.3% decline in the Dow Jones Industrial Average from its December high, this indicator has sounded the alarm for the overall stock market.

Todd Sohn, Managing Director of ETF and Technical Strategy at Strategas Securities, stated, "As a risk barometer, this is not a good sign for the overall market."

Todd Sohn added that the weakness in the two major Dow indices highlights that different sectors of the market are rapidly sending bearish signals, noting significant declines in homebuilders, chip manufacturers, and industrial stocks.

Weakness in Transportation and Consumption Signals Economic Distress

The weakness in the transportation sector reflects broader economic issues. The Dow Jones Transportation Average is viewed as an important indicator of consumer and industrial demand. Its sharp decline indicates that market concerns about the economic outlook are intensifying.

Lee Klaskow, a senior analyst at Bloomberg Intelligence, wrote in a report this week, "The animal spirits generated after the presidential election seem to have given way to increasingly pessimistic sentiment regarding the potential impact of tariffs on U.S. inflation and economic activity."

He noted, "The economic transition is unfavorable for freight demand," and referenced President Trump's comments over the weekend that the U.S. economy is facing a "transition period."

Recently, several airlines and retailers have issued cautious earnings outlooks, further confirming market concerns. Reports indicate that this week, Delta Air Lines Inc. halved its profit expectations, while American Airlines Group Inc. stated that its first-quarter losses would be about twice the previous guidance. Retailers such as Dick’s Sporting Goods Inc. and Kohl’s Corp. also provided sales forecasts that fell well below expectations. All of these indicate that businesses and consumers are under pressure in an uncertain macroeconomic environment.

Limitations of the Dow Theory

Despite criticisms that the Dow Theory has lost some utility in recent years due to changes in the overall economy, which is now primarily driven by services and technology rather than industrial manufacturing, it is undeniable that the sharp decline in transportation stocks (with the index poised for its largest single-week drop since September 2022) signals greater troubles ahead as the overall stock market has already entered a correction.

In summary, the Dow Theory, as a market indicator that has existed for over a century, issues warning signals that deserve serious attention. Investors should monitor changes in economic data and market sentiment and manage risks accordingly