Transports Lead Cyclicals Higher


When all-time highs in the nation's oldest stock-market index merit only a passing mention in the financial press, it's probably time to take a closer look at the Dow Transports.

The Dow Theory. The recent new highs in the Dow Transports resolved several months of divergence, in which the Transports failed to confirm a series of new highs in the Dow Industrials. With that divergence resolved, a bear-market signal is unlikely in the near term.

Perhaps more to the point, the new highs in the Transports reconfirmed the bullish primary trend under the Dow Theory. When both the Industrials and Transports are reaching significant highs, the primary trend is presumed bullish — and higher stock prices are likely.

Both averages closed at all-time highs on July 12, so the Dow Theory is squarely in the bullish camp. Still, that does not preclude the potential for a market pullback; it means a pullback should be viewed as a buying opportunity.

Cyclical strength. The Transports are economically sensitive stocks, and strength in such names bodes well for the broad market. In our view, the biggest near-term risk to the market is a halt to the rebound in corporate earnings growth. The rally in the Transports suggests the outlook for economic growth is improving.

The Transports' rally has been mirrored by other transportation averages and other cyclical groups. For example, the Russell 1000 Dynamic Index, which includes large U.S. stocks more sensitive to economic and market cycles, has outperformed the Russell 1000 Defensive Index in 2017 — despite a lack of legislative progress in Washington.

The goldilocks scenario. Extended bull markets often end in speculative blow-offs, when investors start to believe the old rules no longer apply. Usually, in the beginning, there is at least some justification for this belief.

Today, a growing number of investors argue the global economy has entered a goldilocks environment, with growth hot enough to fuel corporate profits but not so hot as to trigger a jump in inflation.

Indeed, the gap between yields on 30-year and 10-year Treasury bonds has narrowed in recent months, suggesting long-term inflation expectations have diminished even as expectations for cyclical companies have improved.


History suggests widespread acceptance of the goldilocks scenario would spell bad news for the market. But, for now, increased acceptance of this narrative would bode well for stocks. Our buy lists have more than 94% in stocks.

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