Transports Derailed Again


While the broad market and indexes of small-company stocks reached all-time highs before a recent pullback, the Dow Industrials and S&P 500 Index stalled below their March 2 all-time highs. The Dow Transports, hurt by a March 23 profit warning from railroad Kansas City Southern ($103; KSU), trade more than 4.5% below their Dec. 29 all-time high of 9,217.44. For now, our three-part advice for subscribers is unchanged:

Watch the averages. Without a close in the Transports above 9,217.44, a breakdown below the Jan. 30 closing lows of 17,164.95 in the Industrials and 8,649.32 in the Transports would represent a bear-market signal under the Dow Theory.

Emphasize reasonably valued growers. While we are always looking for bona fide growers with attractive valuations, this approach is working especially well now. With investors desperate for profit growth but mostly unwilling to pay nosebleed valuations, we continue to favor such Overall Quadrix leaders as Corning ($23; GLW), Foot Locker ($62; FL), and Lear ($108; LEA).

Hold about 85% of equity portfolios in stocks. Put the remainder in a short-term bond fund like Vanguard Short-Term Corporate Bond ($80; VCSH).

Broad market versus Transports

Helped by a shift toward smaller companies with less foreign exposure, the S&P MidCap 400, S&P SmallCap 600, and Russell 2000 indexes reached all-time highs on March 20. So did the advance-decline line for the broad S&P 1500 Index, a running total of advancing minus declining stocks.

Among the 155 equal-weighted groups tracked in our Industry Group Studies report, only 42 have negative year-to-date returns. And among the 10 major sectors of the S&P 500 Index, energy, industrials, materials, and utilities have negative year-to-date returns.

Given the broad market's strength, some question whether it makes sense to attach so much importance to the Transports. We think the answer is yes, for several reasons.

First, the Dow Theory is a system, and a system needs clear rules. That does not mean you should set your portfolio as 100% stocks or 100% cash based on the Dow Theory, but one of the system's attributes is its clear bullish or bearish verdicts.

Second, the Dow Theory is already in the bullish camp, and it won't turn bearish merely because the Transports stall. A move to the bearish camp would require a breakdown to significant lows in both the Industrials and Transports.

Third, the Transports provide a unique perspective on the more cyclical aspects of the U.S. economy, and history suggests it is hard to make money in U.S. stocks when the outlook for these parts of the economy is deteriorating.k

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