Some Technical Analysts have pointed out the divergence between the Dow Industrials and Transports lately. Basically, a new high on the Dow Industrial Avg (INDU) should be confirmed by a new high on the Dow Transportation Avg (TRAN) to be considered “healthy”. Really, the confirmation between the two averages is just one more breadth indicator. As you may be aware, lots of Technical observers have noted that we are seeing questionable breadth (broad market participation) on the markets these days. I’ve noted discrepancies in new highs vs. new lows, stock over their moving averages and advances vs. decliners lately – as have other Technical people. I’ve even ranted on BNN about the concentration on just five stocks on both the S&P500 and the NASDAQ. Here’s the link to that show.
Of late, the Dow non-confirmation signals between INDU and TRAN (that is, INDU making new highs while TRAN moved down) have not been successful signals for an impending selloff. Two signals over 2017, clearly marked on the chart below- failed miserably. The TRAN went down, and the INDU ignored that divergence by rising further in the spring and summer. The TRAN is diverging right now, but this time we are finally seeing a bit of weakness in the INDU (and broad markets). Perhaps the most recent divergence between the indicators may signal a correction. Or not.
Despite the last two failures, you can see on this chart that its typically a pretty good signal. On my blog posted mid-2015 I noted a divergence. After that blog was written it proved accurate in signalling the volatility that began later that year. I posted a video on that blog explaining the theory—you might enjoy it.
Perhaps the TRAN signal will prove false again. I’ve had people ask me if the markets have moved into a new paradigm where breadth, seasonals, sentiment etc no longer matter.
The last time people asked me that was in late 1999 and through 2000, when I got similar signals (head fakes) from these indicators – well before the markets started falling.
But when they fell , they fell hard.
So – you make the call. Do we continue to ignore the man behind the curtain, or do we pay attention this time? For my part, we’re focusing on undervalued stocks and still holding 20% cash in our equity model. We know the man is there, and we’re ready to call him out if the Great Oz stops granting the market’s wishes.