Transports on the move
Concerns regarding surging energy prices have taken some steam out of the market’s rally, and a near-term pullback in the averages would not be surprising. But, with the Dow Theory squarely in the bullish camp and quality stocks available at attractive valuations, a constructive stance remains appropriate. Our recommended cash position, now 15% to 20%, is likely to be reduced as opportunities develop in individual stocks.
For critics of the Dow Theory, its reliance on the Dow Transports is among the most frequent criticisms. With transportation less important in an increasingly digital and services-oriented economy — and transportation stocks now a very small part of the stock market’s value — why should so much depend on the 20-stock Transportation Average?
Such criticisms miss the point. The Dow Theory works, at least in part, precisely because the Industrials and Transports do not always move together. The Industrials represent the most actively traded, closely followed blue chips. The Transports represent railroad, trucking, shipping, airfreight, and airline stocks — historically good barometers for the more cyclical parts of the U.S. economy.
Only when the Industrials and Transports agree that the market’s primary trend has shifted — by reaching significant highs or significant lows — does the Dow Theory’s verdict on the outlook change. By insisting on confirmation from both averages, Dow Theorists reduce their risk of being whipsawed by short-lived market moves.
Moreover, the Transports have been a leading and highly effective barometer for the broad market in recent years. The Transports led the way in the 2003-to-2007 bull market, defying bears who felt the U.S. economy would wilt because of higher energy costs. The Transports turned lower in mid-2007, presaging a downturn in the broad market.
Today, the Transports’ trend is unequivocally bullish. In fact, the Transports are trading within 5% of 5,446.49, the all-time high reached in July. While 5,446.49 has no significance under the Dow Theory, a move to all-time highs would provide further evidence that investors are anticipating improvement in the economy. Other indicators of economically sensitive stocks are also showing strength, suggesting the Transports are not providing a false signal.
Subscribers should maintain a constructive, opportunistic stance toward equities. Timely buys include Qualcomm ($45; NASDAQ: QCOM) and Transocean ($158; NYSE: RIG).