Following the Tracks of the Dow Transports May Give Clues to the Market
Who cares about the transports?
That was the question I was asked in a radio interview on May 17. The producer of the program asked me what topic I would like to discuss, and when I said the Dow Jones transports, the young man was puzzled I chose a topic on which there was so very little interest. The radio producer, needless to say, is not the only observer who has so little regard for the transports.
However, at the time, the transports were telling a very interesting story on the market, as they were not confirming the records set in the other indexes, such as the Dow Jones industrials and the S&P 500.
First, a brief background on the transports, the importance of the confirmation tenet, and their validity for market forecasting. While I have covered this material before, it is amazing how useful the transportation analysis remains in market interpretation.
The Dow Jones transportation average is part of the theory of stock market movements as expressed by Charles Dow back in the early 1900s, Dow being one of the more prescient on the financial scene as the first editor of the Wall Street Journal and Barron's and one of the co-founders of Dow Jones & Co.
Dow's first "index" (actually, an average) was largely comprised of the railroad issues, as they were the dominant financial issues of the day. Dow later added the industrials to represent, of course, the industrial sector of the economy. The original stock market forecasting theory was based on these two indexes as being representative of expectations as to the future course of the economy-production and shipment of goods-a fairly commonsensical notion.
However, the most important nuance of the Dow Theory is the confirmation tenet: Dow noticed that the degree of stock market forecasting reliability based on the two indexes was directly related to the degree to which the indexes were confirming one another.
Stated differently, non-confirmation between the two indexes usually reflected a degree of uncertainty that typically precedes a change or a pause in trend, if not a reversal, in the market and in the economy, implications that are as pertinent today as in Dow's day.
There is a sort of "Archie Bunker" criticism of the Dow Theory based on the premise that in Dow's time, the rail index was the rails, but now the rail index has become the transportation index, and the underlying theory regarding the role of production and shipping in the economy is no longer valid. However, the current nature of the transports is precisely what makes the transports just as valid to the theory today, if not more so!
The transports today do represent selected rail issues but also include airlines, shipping, and trucking issues. The index has become more encompassing, but in doing so, it has evolved into one of the more sensitive of the market indexes. Because the transportation sectors of the economy tend to be more cyclical and reflective of the course of future profits, the transports are more often than not apt to be the tail that wags the dog. Given the increasing debate between a soft or a hard landing, any market analysis worth its salt should include the transports.
The Three Trends
Part and parcel of trend analysis involving the interaction between the industrials and the transports are the three trends of the market: the minor, or day-to-day; the intermediate, or week-to-week and month-to-month; and the major trend, lasting up to a year or more.
First, some comments on the intermediate trend, which is depicted in Figure 1.
In mid-May the atypical financial reporting was comprised of stock market analysts pointing out the string of back-to-back records, as day after day the Dow industrials (and other indexes, if you wish) were moving to new highs. But the transports were not riding the same rails.
While the Dow Jones industrial average was on the fast track, moving past 4200, 4300, 4400, 4500, and reflecting increased bullish euphoria, the transports in mid-May had been essentially flat since early April-a classic non-confirmation.
Non-confirmation after an extensive advance is never positive, and the market suffered its worst decline in four months on May 18. On the New York Stock Exchange, declining issues of 1780 significantly exceeded advances of 552, which often serves as an advance warning of an important drop three to four weeks hence following the next rally.
Still, a one-day decline is just that, a minor setback. And, as events unfolded, strength in the airlines moved the transports up sharply to new highs on June 13, ending nearly two months of sideways movement. However, the question is whether the June 13 rally is the start of a sustained move, or just minor temporal strength, only to be followed by renewed non-confirmation.
Given the strength of the market into early May, I would not be surprised to see a new high, or even a series of new highs, in the Dow and the S&P 500.
However, any renewed non-confirmation by the transports will suggest that the market will only achieve marginal new highs, followed by ever sharper declines. "Buyers on dips" will bid stock prices up, but the intensity of selling will increase significantly.
Only time will tell as to the characteristics a correction will take, but the longer any non-confirmation, the more severe the eventual decline that finally brings the market back into line with the transports. As in Gresham's Law, weakness will eventually drive out the strong, and such is usually the case with a weakening transportation index.
Where Do the Longer-Term Tracks Lead?
There is a more troubling implication as expressed by the transports-their longer-term trend. While the Dow industrial average and other indexes are at all-time highs, the transports, even with a stellar advance in 1995, are trading just about at their same levels as one year earlier as can be seen in Figure 2.
Not to develop resistance theory too much, but resistance is determined by volume of trading, and the heavy volume of trading around 1700, at the base of the transport's major distribution pattern a year earlier, is causing some problems. Simply, the advance has run into too many investors looking to get out.
You say: "That's nice, but so what?"
Well, compare the current pattern to an earlier period, in 1990 (see Figure 3 on the following page).
In 1990, the laggard transports-the more sensitive index-were forecasting an eventual decline in the broader indexes, such as the Dow industrials and S&P 500, of about 20%. The more glamorous indexes, like the Nasdaq, suffered losses 50% worse.
If the market only declines in extent to its "average" intermediate correction of 7% to 8%, the decline should stop after a few hundred points. Let's hope that the transports are only forecasting a moderate correction in an ongoing bull market.
However, one proverb reads to the effect that those who ignore history are doomed to repeat it. If the transports continue to not only not confirm, but worse yet, begin to lose ground relative to the other indexes, it likely means something more ominous for the overall market and perhaps a "hard landing" for investment portfolios.
While the financial news always dutifully reports on the Dow industrials and the S&P 500, investors might want to keep an eye on the transports.