Ask Colin

With the demise of the ASX Industrials and Transport indexes, what indexes should now be used for Dow Theory?

Even before the demise of the ASX Transport sector index, there were some problems with it. It contained some stocks that had substantial overesas transport operations and also some stocks with significant non-transport operations. However, it was the best we had.

The Industrials index also had some problems because it included many companies, some of them very large, that had significant overseas interests. Also, some of them were not really traditional industrials companies, in that they operated in the finance or services sectors. This latter consideration may not be fatal, because banks, for example are affected by levels of industrial output, as are service companies who have industrial companies as their client base. However, I think that there is a case for being cautious, because they would only be affected after a time lag, so "polluting" the indicator. Banks have recently been quoted as being 25% of the Australian stock market, so it is not a small problem.

To the extent that the old Industrials index was acceptable for Dow theory, I think we could use the All Ordinaries or ASX 300. Resources have shrunk to a small proportion of the market compared to what they were a couple of decades ago. It is not really satisfactory, but could be used as the best we have.

Transport is a more difficult problem in one way, but easier now in another. It could be easier in that the new GICS system of sectors will have a transport sub-sector that should be fairly "pure". However, the problem is that the ASX/S&P monopoly pricing means that non-professional investors do not have access to it yet at a reasonable price. Institutions have it, but the small investor does not.

If you want to continue the classical Dow Thory analysis, the best approach might be to construct your own averages in a spreadsheet. I would do this by taking the 30 largest pure industrial stocks and averaging their prices daily.

You would then do the same with say the largest 10 pure Transport stocks.

However, before you bolt off and do this, it is not as easy as it appears. You have to deal with shares issues and reconstructions, not to mention takeovers. Also the stocks in the averge would need to change from time to time. Constructing an average or index is a difficult thing conceptually and can get quite complicated.

I hope this helps you work through the issues. Myself, I am resigned to no longer being able to do this analysis on the Australian market. The confirmation of averages was an interesting concept in the days when most stocks listed were manufacturers and railways. The modern industrial economy has become far more diverse and transport is now also a far more diverse idea with trucking companies, shipping companies, airlines, couriers etc. It seems to me that we have been "pushing the envelope" on this method for quite some decades. Perhaps it is time too allow it to rest in peace.