The Dow Theory contains a tenet suggesting the Dow Transportation index must confirm the highs and direction of the Industrials. As I, and other Technical Analysts have discussed over the past weeks – we are currently witnessing a divergence in the direction of the Transports vs. the Industrials.. The DJTI has been moving down since February. So too has the TSX Transports Index, which has experienced an even greater pullback.
Interestingly, both US and CDN Transport indices have fallen on the backs of continued gains in both revenue and profits. Southwest Airlines and Alaska Air Group in the air carrier group reported solid first quarters, as did CSX Rail. Canada’s rails, CP and CNR also had good Q1’s, as did trucking company TransForce. Our major carrier Air Canada had higher cash flow (although still reported a net loss).
After the tech bubble in 1999 imploded, transports became the “can’t lose” category. They lead both sides of the border in performance from 2000-2014. Canadians, longing to own anything solid that might diversify us outside of our bank and oil holdings, happily bought into this sector—with particular emphasis on the rails. It’s been the right thing to do for 14 years, but that era may be over for the long termed investor.
Getting back to Dow Theory’s divergence principal – Despite the theory’s faults (it tends to either lag or lead a correction by long time periods), the indicator has rarely missed a market correction when Transports diverge (this according to Dow Theorists who keep long termed performance records)– as they are now. Thus, we should pay attention to this signal, bearing in mind its often frustratingly slow signal time length. The chart below shows us the performance of the Dow Industrials following a divergence in the transports since 1990.
While a healthy dose of caution should be observed based on the current Dow indices divergence- it should be noted that a break to a new high by the transports would negate the current signal. Lower fuel costs – which are typically bullish for Transports- haven’t helped motivate buyers yet. High PE ratios (20 vs. historic 16) may be one factor containing a rally for the Transports. The presence of the multi-month sideways trading range on the Industrials may be suggesting that the broader market may indeed be setting up to prove the Dow Theory’s bearish divergence correct. Should the Transports not rally to new highs soon- things may get ugly on the broader stock market. Ignore the signal at your own peril.
Last week’s BNN show with Keith
Click here for the Top Picks portion of MarketCall Tonight on Tuesday July 14, 2015.