Stock Bulls Shudder as the Dow Theory Is Tested

Even though U.S. stocks have rebounded to new highs this month, it’s been hard to find anything close to animal spirits. And Wednesday’s weakness in equities – although mild, with the Dow Jones Industrial Average falling less than 0.5% – demonstrated why investors are still holding higher-than-average cash balances in a clear sign of caution.

The Dow Theory, which has been around for more than a century, holds that if either the benchmark Dow Jones Industrial Average or the Dow Jones Transportation Average reaches a new record, the other must soon follow to confirm a bullish outlook. The broad Dow gauge has done its part, but the transport index, whose constituents include economic bellwethers such as railroad Norfolk Southern Corp., package-delivery company FedEx Corp. and trucking firm Ryder System Inc., hasn’t. In fact, the performance of the transports has only become worse relative to the broader DJIA in recent weeks, culminating in a slide of 3.59% on Wednesday that was the worst since early December. The troubles facing the economy were underscored by railroad operator CSX Corp., which cut its revenue outlook for the year on Tuesday. CSX is no outlier. The Cass Information Systems’ Freight Index indicates a 5.3% drop in shipments in June, the seventh straight monthly decline, according to my Bloomberg Opinion colleague Brooke Sutherland. Cass, whose data is based on $28 billion in annual freight transactions annually, said the ongoing string of declines signals we’ve moved past “`warning of a potential slowdown’ to ‘signaling an economic contraction.’”