Lagging Transports Draw Notice

4/3/2017


A recent eight-session losing streak for the Dow Industrials, the longest since 2011, generated a lot of headlines. But many market watchers were more worried about the nearly 7% pullback from the March 1 highs in the Dow Transports, especially because the Transports have lagged throughout 2017.

After a recent bounce in both averages, the Industrials have gained 4.5% so far this year, versus 0.3% for the Transports. In another worrying divergence, the Russell 2000 Index of small stocks has advanced just 1.1%.

Small stocks tend to underperform in the later stages of a market rally, while the cyclical Transports can provide an early warning of trouble in the economy.

Based on a recent piece in Barron's, investors are right to worry about chronic underperformance from the Transports. Of the 16 bear markets since 1929, 14 came after extended periods of relative weakness in the Transports, according to data supplied by Leuthold Group.

But Leuthold's chief investment officer says the Transports typically lag for 11 months before a market top — and short periods of relative weakness like that seen since early December don't have much predictive value.

Not all market watchers are so sanguine. In March, Schaeffer's Investment Research looked at three-month periods in which both averages advanced but the Transports lagged the Industrials by a wide margin. On average since 1950, the Industrials have been nearly 0.2% lower three months after such periods, compared to an average gain of 2% in all three-month periods, according to Schaeffer's.

From a Dow Theory perspective, the Transports' recent underperformance is worrisome but not critical. Nor does it matter that the Transports recently broke below their January low. What matters is the Transports' ability to rally to new highs after a pullback.

A rebound above the March 1 closing all-time highs of 21,115.55 in the Industrials and 9,593.95 in the Transports would reconfirm the bullish primary trend under the Dow Theory. If one or both averages fail to rebound to fresh highs after significant corrections, the stage would be set for a bear-market signal.

Conclusion

The recent underperformance of the Transports is grounds for concern, and subscribers should keep a close eye on the averages. But the Dow Theory remains in the bullish camp, and raising cash seems premature at this point. Our buy lists have at least 94% in stocks. For new buying, Synchrony Financial ($34; SYF) has pulled back to an attractive range.


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