For believers in classic Dow Theory, the Dow Jones Transportation Index (DJT) is sending a warning sign. Dow Theory says in order for a new high in the Dow Jones Industrial Average (DJIA) to be meaningful, it needs confirmation from a new high in the DJT. And right now, that’s not happening.
On Tuesday, the Dow crossed 13,000 amid vapid fanfare on the network news broadcasts, establishing a new 52-week high at 13,005. However, the DJT is telling a different story: At its Tuesday close of 5,163, it stood a full 9% short of its 52-week high of 5,628. What’s more, the transports are showing signs of rolling over. Since the start of the month, the DJT has slipped 2.9% even as the DJIA has gained 2.6%.
The primary culprit, as Tyler Craig outlined in a Wednesday article on InvestorPlace, is rising oil prices. As crude has surged past $105 a barrel, airlines have taken it on the chin in a reversal of what had been their exceptionally strong year-to-date performance. Rail stocks have also underperformed the broader market this month, but to a lesser extent than the airlines.
The primary question is whether this element of Dow Theory matters. After all, transports account for a much lower share of the economy today compared to when this concept first emerged more than 100 years ago. But if some recent occasions of DJT underperformance are any indication, we may be in for weaker performance for the broader market in the weeks ahead.
Click to EnlargeThe first case of a DJT rollover occurred in late 2007. The DJT hit its peak in the week of July 27 and began a steady decline that lasted through year-end (first chart on right). While the transports subsequently retested their old high, this initial weakness foreshadowed the top that occurred in the industrials during the week of Oct. 8. And as we all know, the markets were subsequently taken out to the woodshed in 2008.
The DJT also provided a signal of impending market weakness in September 2008, when it broke down to new lows slightly ahead of the industrials (second chart).
Click to EnlargeAnother notable example of the transports providing a signal occurred in 2001. The DJT experienced a series of lower highs, even as the DJIA continued to move sideways (third chart). This divergence preceded a major sell-off three months later.
Click to EnlargeFinally, the last chart shows the DJT versus the DJIA. An upward sloping line indicates outperformance for transports, while a downturn indicates underperformance. This shows that periods of underperformance for the DJT typically precede or coincide with downturns in the broader market, but rarely are accompanied by broader market strength.
Click to EnlargeLike any indicator, the relative performance of the transports can sometimes provide misleading signals. However, the 5.5 percentage-point shortfall in the DJT so far in February heavily tilts the odds in favor of near-term market weakness — particularly with the broader indices having come so far in recent months.
