NEGATIVE DOW THEORY TRENDS -- TRANSPORTS LEAD INDUSTRIALS LOWER AS BOTH NEAR DOW THEORY SELL SIGNAL -- UTILITIES OUTPERFORM INDUSTRIALS AND TRANSPORTS WHICH IS ANOTHER SIGN OF WEAKNESS
TRANSPORTS LEAD INDUSTRALS LOWER ... We've been writing about a lot of negative stock market signals of late which include bearish chart action, as well as recent rotations out of small caps and technology and into traditionally defensive groups (that pay dividends). This morning's message will focus on negative market signals (for the stock market and economy) coming from the relative action in the three Dow Averages -- the industrials, and transports, and the utilities. The most obvious negative sign is coming from traditional Dow Theory, which compares the trend action in the industrials and transports. Charts 1 and 2, for example, show that the ability of the Dow Industrials to exceed their June high (Chart 1) was unconfirmed by the Dow Transports' inability to do so (Chart 2). That was the first warning sign. The second is coming today with the Dow Transports slipping below its late July intra-day low at 4054 in morning trading. At the same time, the Dow Industrials are threatening their late July low at 10007. A close by both Dow Averages below those pevious support would (in my opinion) represent a Dow Theory sell signal. That would pave the way for a more serious test of their July lows. The falling relative strength line (below Chart 2) also shows the transports underperforming the industrials throughout August. That's another negative sign since transports are more cyclical in nature and more reflective of economic trends. A second negative sign comes from Chart 3 which shows the Dow Utilities holding up the best of all. Their rising relative strength line (below Chart 3) is another negative sign for the market.
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Chart 1
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Chart 2
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Chart 3
COMPARING TRANSPORTS AND UTILITIES ... Another way to measure the strength or weakness of the stock market and economy is to compare the relative performance between the Dow Transports (a cyclical group) to the Dow Utilities (a defensive group). The logic is pretty clear. Transportation stocks measure the flow of goods and help determine the strength of the economy. As a result, they should do better in a strengthening economy. The Dow Utilities, by contrast, are more defensive in nature. They tend to underperform in a stronger econony. They do better, however, when the economy (and stock market) are weakening. I find that a direct comparison between the two Dow groups provides a decent snapshot of which way things are moving. Chart 4 is a relative strengh ratio of the transports (blue line) to the utilities (flat black line) over the last two years. The transports undeperformed utilities during the second half of 2008 (when things were weakening), outperformed during 2009 (when things looked better), and are underperforming in 2010 (see trendlines and arrows). Chart 5 simply flips things around to show the utilities (blue line) starting to outperform the transports (flat black line). There are at least two conclusions that can be drawn from both charts. At the moment, utilities are a stronger investment than transports. And, for as long as that trend continues, the stock market will remain on the defensive. That also favors defensive groups (like consumer staples, healthcare, telecom, and gold) over cyclical groups (like small caps, technology, energy, and basic materials). That negative trend also continues to favor bonds over stocks.
Chart 4
Chart 5
