ANOTHER VERSION OF DOW THEORY PAINTS WEAK PICTURE AS UTILITIES BREAK OUT VERSUS INDUSTRIALS AND TRANSPORTS -- BIG PHARMA LEADS HEALTHCARE GAINS -- GOLD HITS NEW RECORD
WEAKNESS IN THE DOW TRANSPORTS IS BAD SIGN ... A lot of information (both market and economic) can be found in the interaction between the three Dow Averages. The most common is the relationship between the Dow Industrials and Transports, which is referred to as Dow Theory. That theory holds that both have to rise together in a bull market. A serious breakdown in one is often a warning of weakness in the other. We've written several times about the negative implications of the past year's breakdown in the Dow Transports. Chart 1 shows how bad the divergence has gotten between the Industrials (black line) and Transports (blue line) over the last year. Chart 2 makes the point even more clear. In that second chart, the Dow Transports (blue line) are plotted around the Dow Industrials, which are the flat black line. That produces a transportation/industrial ratio that has fallen to the lowest level in more than three years. The last time the transports underperformed the industrials by that much was from 1998 to 2000. That earlier period also saw rising energy prices and gave an early warning of a market top in 2000 and a recession the following year. A breakdown in fuel-sensitive transportation stocks is the market's way of telling us that rising energy prices are starting to slow the economy. That also explains why the Dow Utilities are doing so well.
Chart 1
Chart 2
UTILITY LEADERSHIP IS A SIGN OF WEAKNESS... Since utilities are often viewed as a proxy for bonds, they do better when the economy is weakening (and interest rates are dropping). The fact that they pay dividends is another plus in a defensive market. That's why comparing the performance of the Dow Utilities to the Dow Industrials and Transports is also instructive. Chart 3 plots the Dow Utilities (blue line) relative to the Industrials (flat black line) since 1996. That chart shows the utility/industrial ratio breaking out to the highest level in more than a decade. Notice the upturn in the ratio from 2000 to 2001 in the early stages of the last bear market. Chart 4 compares the defensive utilities (blue line) to the economically-sensitive transports (black line). The utility/transport ratio rallied from 1998 to late 2001 as the market was peaking eight years ago, and declined during most of the ensuing bull market. After bottoming in 2006, the ratio has now broken out to a new six-year high. In my view, those two ratios tell us two things. First, they tell us that utilities are a better place to be than transportation stocks or industrials. I also view the utility/transportation ratio as a barometer of confidence in the stock market and the economy. When the transports are in the lead, the market mood is optimistic. When the utilities are in the lead (as is presently the case), the market and economic mood is defensive.
Chart 3
Chart 4
DEFENSIVE HEALTHCARE SECTOR TELLS THE SAME STORY ... Utilities aren't the only defensive stocks that are attracting more money. So are consumer staples and healthcare. Last week, I showed those three groups to be the market's top performers (outside of commodities). We're going to focus on healthcare today. Chart 5 compares the performance of the Healthcare SPDR (blue line) to the S&P 500 black line. [Relative performance tells us a lot more than just absolute performance]. There are three distinct trends on the healthcare/S&P ratio. The first two show an uptrend from 2000 to 2003 during the last bear market, and a downturn from 2003 to 2007 in the last bull market (see arrows). That's exactly how a defensive group should act. It should underperform during a market upturn and outperform during a market downturn. After bottoming in mid-2007 (right around the time subprime problems surfaced), the ratio broke a four-year down trendline and has broken out to the highest level in three and half years. That also tells us two things. First, that healthcare is a good place to be. And, second, that the investors are losing confidence in the market.
Chart 5
PHARM HOLDERS ARE CATCHING UP... Chart 6 overlays the monthly price bars for the HealthCare SPDR (XLV) on its relative strength ratio (solid line). The monthly bars appear to be consolidating well above their 2000 highs. A run at the 2007 high appears likely. A lot of this week's healthcare buying is coming in the big pharmas. Chart 7 shows Pharm Holders (PPH) consolidating above their 2003 peak. Notice the recent upturn in the PPH/SPX ratio (solid line) in Chart 7. Up to now, big pharma has been a market laggard. But that may be changing.
Chart 6
Chart 7
GOLD PACES EARLY 2008 DEFENSIVE LEADERS... Although the new year is less than a week old, some early trends are evident. With the market losing ground, the only winners are in defensive stocks. In fact, the only two sectors in the plus column since the start of the new year are utilities and healthcare. In the latter group, pharmaceuticals and biotechs are in the black. Gold is the top performer with bullion surging to another record high today. Gold stocks are up more than 5% on the day and are the market's strongest group. Chart 8 shows the Market Vectors Gold Miners Index (GDX) nearing a test of its November high. Its relative strength ratio has already hit a new high. Surging gold prices are feeding off a weak dollar and a struggling stock market.
Chart 8
