As we highlighted in last month’s blog, Dow Theory for the 21st Century gave a ‘Sell’ signal on US equity markets on 22nd February last. An initial further fall has been followed by a strong recovery, however, leading to a secondary reaction with both the S&P 500 Index and Dow Transports Index closing above the pre-sell bounce highs. Should the Dow Industrials Index follow suit, we will get a reversal of the previously mentioned ‘Sell’ signal.
There has also been plenty of discussion about the US yield curve inverting – a traditionally reliable leading indicator of a recession. Many market commentators look at the 2-year interest rates in the US being above 10-year interest rates and are pointing to this as evidence of a US yield curve inversion. However, Dow Theory points to the 3-month interest rates being above 10-year interest rates as the critical signal – which is not the case at present.
The significance of a yield curve inversion is that higher short term interest rates signal the desire by the central bank to cool an economy. Investors in longer term government bonds, however, know that when the economy has cooled (or is in recession) interest rates will most likely decline again, so that there is no real need to push longer term interest rates higher.
As always, reading these market and economic indicators is difficult. However, the stock market is the leading indicator, not the economy. So we will be keeping our eyes on the Dow Industrials Index. Any changes to the most recent Dow Theory ‘Sell’ signal will be communicated to members of our website.