The Industrial Production Index

There are three components to Dow's Theory, the movements of the Dow Industrials and Dow Transports are the first two. The final piece to Dow's Theory was called Barron's Business Index or the Barron's Monthly Index of the Physical Volume of Industrial Production and Trade. Unfortunately, After contacting the statistics department at Barron's and the Wall Street Journal I was told that the Barron's Business Index was discontinued in 1938 leaving Dow Theory adherents without a reasonable "real-time" measure of general economic activity.

As an alternative, I have decided to go with the Industrial Production Index (IPI) published by the Federal Reserve Board. To get a detailed review of the viability of the IPI as applied to Dow's Theory, I strongly recommend that you get your hands on the book "Priniciples of Professional Speculation" by Victor Sperandeo. The nice part about the IPI is that when compared to the Barron's Index from 1919 until 1938, there is almost no difference between the two economic indicators. The most important concern about a business activity index like this is that it is as close to real time as we could get. The Industrial Production Index lags the real economy by 2 months at the most. This is contrasted by organizations like the National Bureau of Economic Research (NBER) which routinely reports 1 to 3 years after the fact that the economy has either hit a bottom or a top.

On the right hand column, I have added the final piece to the necessary elements of Dow's theory as was originally intended by Dow, Hamilton, and Rhea. You'll see the Dow Industrials, Transports and the Industrial Production Index. When all of these indices indicate that they are either falling or rising, at the same time, then you will know right away the general direction of the market. Also important is the relative values within the market. The relative value of the market is indicated by the Dow Yield indicator. This will tell you that, regardless of the direction of the market, there are either few or many investment opportunities in the stock market.

Now, let us look at the IPI and see what it could be telling us about the real economic activity from a technical analysis basis. On the chart below, I have included the IPI chart from 1996 until October 2008. From the period of Dec. 2001 until Jan. 2008, we see the rise of the index by 14.73 points. Using Dow's theory, the index is supposed to have support levels at 107.66, 102.75 and 97.84. After breaking through the first support level of 107.66 the index fell to the low of 105.95 in Sept. 2008 before rising to 107.29 in October 2008.

On the chart, I have indicated the resistance level (dark blue line) where the index needs to go above to truly confirm that we might be coming out of this bear market. If the IPI cannot go significantly above the 109.26 level, then the potential exists that the economy could contract even further. Any further decline in the economy could take us back to the 97.84 level, a 9% reduction in business activity.

So far we have the Dow Transports and Industrials with lows established on November 20th. The September low of the IPI needs to continue above the 109.26 level to resoundingly confirm the end to the bear market. Remember, the end of a bear market is not the automatic beginning of a bull market. Therefore, once the end to the bear market is confirmed we will also need confirming action in the indices to show us that a bull market has begun. Touc.

Sources:

• Sperandeo, Victor. Trader Vic II- Principles of Professional Speculation. John Wiley & Sons, Inc. 1997.