DOW TRANSPORTS HIT RECORD HIGH -- DOW THEORY UPTREND REMAINS INTACT, BUT NEEDS A NEW INDUSTRIAL HIGH TO CONFIRM TRANSPORTATION BREAKOUT -- FALLING BOND YIELD GIVES BOOST TO UTILITY STOCKS WHICH HAVE BECOME MARKET LAGGARDS
TRANSPORTS HIT RECORD HIGHS AS INDUSTRIALS LAG... During the summer, we wrote about bullish signals given by the Dow Theory. That theory holds that a major uptrend is intact when the Dow Industrials and Transports are hitting new highs together. That positive event took place during August and September (see rising green lines in Charts 1 and 2). The September/October selloff had little effect on the Dow Transports. Its October low formed well above its late August low which maintained its bullish pattern of "higher lows" (rising black trendline). Since then, the Dow Transports has surged to a new record high. More impressively, its relative performance line (below chart) has surged to the highest level in six months. That's normally a good sign for the stock market because stronger transports suggest a stronger economy. Chart 2 shows a weaker picture for the Dow Industrials which fell during October all the way to its late August low and its 200-day average. My October 10 message pointed out that the ability of the Dow to bounce off those support levels kept the Dow Theory uptrend intact. To reconfirm that uptrend, however, the Dow Industrials need to clear their September highs. The relative performance chart (below Chart 2) shows weak performance by the Dow. That's not necessarily a bad thing. During market uptrends, the Dow Industrials often lag behind riskier (like small caps) and economically-sensitive groups (like transports). At the moment, the Dow is the only major U.S. stock average that hasn't hit a new record. Technical odds, however, favor that happening eventually.
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Chart 1
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Chart 2
FALLING BOND YIELDS HELPS UTILITIES ... The Dow Utilities have been the weakest part of the Dow family. That's due largely to interest rate trends. The upward spike in the 10-Year Bond Yield (green line) during May pushed interest-rate sensitive utility stocks sharply lower. The peak in the bond yields in early September has pushed the Dow Utilities to the highest level in two months. The relative performance line (below chart) is levelling off after dropping between May and August. Since utilities pay big dividends, they benefit from lower bond yields. If and when bond yields start rising again (probably during 2014), utilities will most likely continue to underperform. Since utilities are a defensive group, and transports are economically sensitive, it's normally a good sign for the market when the transports are leading the market higher and utilities are lagging behind.
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Chart 3
HOMEBUILDERS AND REITS ALSO BOUNCE WITH BONDS ... Two other rate-sensitive groups that are benefiting from falling bond yields are homebuilders and REITS. In fact, the two charts shown look very much like the utility chart in the preceding paragraph. Chart 4 shows the Dow Jones U.S. Home Construction ETF (ITB) attempting to form a bottom after peaking during May. Chart 5 shows an even stronger pattern in the Dow Jones REIT Index (RWR). Like utilities, their fate depends on the direction of bond yields (and prices). The green area on both charts plots the direction of the 20 Year T-Bond Fund (TLT). It's clear that homebuilders and REITs have been falling and rising with bond prices since May (as have utilities).
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Chart 4
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Chart 5
CONSUMER STAPLES ETF HITS NEW HIGH... My last message suggested that an upside breakout in the telecom group was largely due to the drop in interest rates. The same is true with consumer staples. Chart 6 shows the Consumer Staples SPDR (XLP) also breaking out to a new record. The gray area shows that staples have been market laggards since May when interest rates started to spike. The XLP/SPX ratio has started to bounce during October as bond yields have fallen.
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Chart 6
BREADTH INDICATORS IMPROVE... My October 8 message expressed concern about weakness in some market breadth indicators. The good news is that they've shown improvement since then. Chart 7 plots the NYSE Bullish Percent Index ($BPNYA) which plots the percent of NYSE stocks in point & figure uptrends. The black line had shown a pattern of declining peaks since May which raised some concerns. During October, however, the line has risen to the highest level in two months (75%) and broke its five-month downtrend. Chart 8 plots the percent of NYSE stocks trading above their 200-day average ($NYA200R). It peaked during May and fell below 60% during the summer. The red line has since risen to 72% and has exceeded its September high in the process. It's now in the process of challenging its July peak. A close above that level would be even better. It's always better when those two lines are rising (as they're doing now) instead of falling.
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Chart 7
