The Dow Theory, one of the oldest investment strategies, appears close to offering a surprising bullish trend signal. If only the flailing airline stocks would oblige.

Airlines are famous for losing money. Lots of it. And this downturn has been especially brutal, with major carriers losing millions per day. With such a nasty financial picture, it's no surprise to see the Dow Jones Airline Index down more than 50% in the past year.

These airline stock woes are impairing the visibility of Dow Theorists. Under Dow Theory, the Dow Jones Industrial Average and the Dow Jones Transportation Average must confirm one another's movements before a new trend can be declared. More specifically, both measures need to hit new highs together (bullish), or new lows together (bearish), for a trend to be in place.

Under Dow Theory, when times were good, the industrials made goods and the railroads delivered them. When times were bad, less was made, less was delivered. This connection provided the fundamental underpinning of Dow Theory.

Charles Dow, a founder of The Wall Street Journal, is widely cited as the father of Dow Theory, but that may be in error. He established the industrial average and the Dow Jones Railroad Average (changed to the transports in 1970) as a way to analyze the market, but he never referred to his analysis as Dow Theory.

William Peter Hamilton, a subsequent editor at The Wall Street Journal, became the chief populizer of Dow Theory in the 1920s. Writing in the Journal, Mr. Hamilton expanded on Mr. Dow's market commentary and often used Dow Theory as a forecasting tool. In the weeks ahead of the 1929 crash, when stock prices levitated higher, Mr. Hamilton wrote -- for the few who cared -- that the Dow Theory showed the market's major trend had turned bearish.

More recently, most Dow Theorists correctly forecast the big market gains in the late 1990s. But many bullish Dow Theorists were late on catching the market's sharp declines that began in 2000.

Today, most Dow Theorists believe we're in "divergence." This is a $10 way of saying "confused." It's a frustrating response, when we expect conviction from theories. But like many long-running predictors, Dow Theory is supple -- loose and overly vague. The practitioner has plenty of room to be "correct," and to explain away mistaken views.

"We've had major capitulation, and such capitulation is always followed by a Dow Theory buy. Just waiting for the Dow Theory to do its thing," says Mr. Schannep. "And the theory is telling us it needs the transports to hold above their bear-market lows and get above 2389.51 (reached July 30, 2002) -- that would indicate a trend breakout." On Monday, the Dow Jones Transportation Average rose 24.62 to 2364.02, within an eyelash of Mr. Schannep's breakout point.

Despite that rise, Mr. Schannep shouldn't expect help from the airlines anytime soon. Airlines hold six of 20 slots in the transports average, and all six of those stocks are behaving in ways that bring air-sickness bags to mind. Last week, US Airways was booted out of the average when it filed for bankruptcy. Continental, another limping airline, replaced it.

"Nothing's going to get better anytime soon," says Holly Hegeman, editor of airline industry newsletter Planbusiness.com. "As far as stocks go, it's insane. The second quarter is usually the best quarter -- and that was bad. And the third quarter is going to be worse. It's awful. Just awful."

That's pretty clear.

But the Dow Jones transports include a lot more than airlines. In fact, the trucking, rail and air transport stocks (not to mention shipping stocks) have held up well, giving the average surprising strength. After closing at 2160.35 on July 23, the transports have staged a smart 9% rally -- all while the airline sector is having its trouble. It's that move that has Mr. Schannep smelling a bullish trend reversal.

Mr. Moroney is concerned that the industrials moved below their post-attack lows during the July decline. Thus, unlike Mr. Schannep, he sees the industrials in a negative trend and the transports hanging onto at least a neutral-to-positive position. His return to a bullish trend scenario is a bit more demanding than Mr. Schannep's. The transports need to rise above 2500, test that level, and set a new high. At the same time, the industrials need to break through 9000, test that level, and stick above that point, setting new highs.

Two Dow Theorists, two scenarios, not too surprising.

"You have to understand that [Mr.] Hamilton never really codified what the Dow Theory was," says Mr. Moroney. "He would say that you don't want to get too hung up on mechanical rules. The interpretation of the Dow Theory is more like piloting a plane than doing algebra."

Right now, the landing lights are fuzzy. Until the airline sector finds its wings, Dow Theorists may have to keep circling.

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