The inflation-corrected Dow has stayed within the channel about
three-quarters of the time. When the Dow broke out of the channel to the
upside, as it did in 1929 and again in the mid-1960s, stocks subsequently
suffered poor short-term returns. Likewise, when stocks penetrated the
channel on the downside, they subsequently experienced superior
short-term returns.BEWARE THE USE OF TREND LINES TO PREDICT FUTURE RETURNS
Using channels and trend lines to predict future returns, however tempt-
ing, can be misleading. Long-standing trends have been broken in the
past. Uncorrected for inflation, the Dow Industrials broke and stayed
above the trend line in the mid-1950s, as shown in the inset of Figure 3-1.
This is because inflation, caused by the shift to a paper money standard,CHAPTER 3 Stock Indexes 41
FIGURE 3–1
The Real Dow Jones Industrial Average, February 1885 through December 2006 (in 2006 Dollars)