Dow Theory “Forecasts” Buy On U.S. Stocks… Will Australia Follow?

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Well, it’s official. It’s time to buy U.S. stocks. And not a moment too soon!

“The oldest gauge of U.S. transportation stocks reached a record last week, with a boost from Warren Buffett. For Keith Wirtz at Fifth Third Asset Management, it’s a sign more gains are ahead for the overall market,” reported Bloomberg in the wee hours of the night. The story referred to the fact that the Dow Jones Transportation Index made a new high. Under Dow Theory, a theory of inter-related economic cycles, this means stocks are a buy.

We like Dow Theory, in theory. But we wonder how useful a theory is which predicts a bull market AFTER everything has gone up. It’s like saying that the secret to investing is to buy only the stocks that go up. Duh.

To be fair, Dow Theory was created by Charles Dow to explain the basic forces in an industrial economy and how they interact. He believed a correct understanding of the industrials (manufacturers of finished goods), the transports (distributors of wholesale and retail goods), and the utilities (the energy suppliers in the whole system) would tell investors where we were in any given business cycle and thus, whether you should be a buyer or a seller.

Does the model really describe the American economy accurately any longer? Railroad stocks-Warren Buffett’s latest moves notwithstanding-are not key to the American economy as they were at the turn of the century. And the Dow Industrials Index is filled with companies like Hewlett-Packard (NYSE: HPQ), Home Depot (NYSE: HD), Proctor and Gamble (NYSE: PG), and Microsoft (NASDAQ: MSFT), none of which are exactly your prototypical industrial behemoths.

And in any event, we’re less and less convinced that the Australian share market is taking its cues from the American market. Australia’s economy and its publicly listed companies are joined at the hip with China more and more, and America less and less. So who really cares what happens in American shares? The only real useful indicator coming from the American market is liquidity. If it vanishes there, it will vanish pretty much everywhere, which is bad for shares. More likely is the steady migration of global money flows to Asia-centric assets and opportunities.

There a few things Australia should keep an eye on from America, though. General Motors (NYSE: GM), once the mightiest car maker in the world, is a shell of its former self. GM’s first quarter profits plunged by 90% to just US$62 million on nearly US$44 billion in sales. The big culprit was the not-so-well-kept secret that GM was moonlighting as a mortgage finance company and hanging out in all the wrong financial, sub-prime neighbourhoods. GM sold its majority stake in its GMAC financing arm last year, but still realized a $115 million loss in the first quarter.

The decline and fall of General Motors is a sign of many things… the rise of China as the world’s low-cost manufacturing centre… the demographic crisis facing Western Welfare states… and the financialization of an American economy that’s been geared to produce asset inflation rather than real wealth or productive capital stock. Does it mean anything for Australia? Well, watch out Australia. Globalisation is ruthless, and unless you can make a thing better and cheaper than the Chinese, manufacturing jobs are at risk.

What Australia has going for it that America does not is its tremendous resource wealth and relative proximity to the world’s largest emerging, resource consuming markets. The downside is that the Australian economy is not terribly diversified. It’s a two-trick pony, with the resources being a draft horse and financial stocks cantering along nicely. This puts the country in somewhat of a mercantilist conundrum, with its growth depending on trends outside the economy. But then again, it’s that way in the whole world these days. Forced to choose which country has the better economic prospects, we have already voted with our feet.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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