Recent swings in the Dow and Nasdaq averages are speaking to a level of volatility that reflects a certain amount of fear in the market. The stock market is said to be driven by two emotions: fear and greed. If fear is currently driving that level of volatility higher, what does that portend for the market?
In order to answer that question, you may want to consider a historical perspective (Dow Theory), the bond market, and current events. Dow Theory (DT) is based on work by former Wall Street Journal editor William Hamilton. This theory tracks both the Dow Jones Industrial Average (DIA aka, the “Dow”) and the Dow Jones Transportation Average (DJT), and states that when both of these averages are performing poorly at the same time it is a “bearish” signal.
Another theory comes from the bond market. This theory is related to predicting economic recessions. The theory is that if there is a yield curve “inversion” – defined as when the longer term 10-year bond yield is less that the shorter term 3-month bond yield, then the economy is weakening and about to turn from expansion to recession. Historically, recessions are extremely bad for the stock market, and they usually precede or coincide with a bear market.
Current events are also signaling tough times ahead. Political instability, in terms of the war in Syria, the continuing wars in Afghanistan and Iraq, and threats of nuclear missile attacks by North Korea, to name a few, are adding to uncertainty. Threats of trade wars with China and other countries are contributing to that uncertainty and fear. Domestic issues of civil unrest, record budget deficits, and political gridlock are “putting out the fire with gasoline.”
Pay attention to the signals, or you may also find yourself in a “crash.”