Transports Are in Freefall - Bad Sign for Dow

Includes: DIA, IYT
by: Barry Ritholtz

I watched yesterday's Transports rally very carefully. One of the technical reasons the markets have been suspect has been the divergence between Transports and the Industrials. As of 10:30 today, the Trannies are off by more that 2.36% -- giving up all of yesterday's merger driven gains -- and then some.

What does this mean for the longer term? Well, if you are a Dow Theorist, you want to see Transports confirming strength in Industrials.

Why? Manufactured products have to get to their products to the buyers, and they must be shipped.

Classic Dow Theory states:

"A failure of the transports to post a new high by year-end would have bearish implications because it would set up a possible Dow Theory sell signal. Dow Theory signals have their origin in Charles Dow's concepts, one of which is that the averages must confirm each other. Dow argued that no important bull or bear market could occur unless the industrial and the rail (transport) averages gave the same signal or confirmed a change in market trend.

Both averages had to move above a previous secondary peak to generate a bull market signal. This price confirmation by both averages should occur at about the same time within a six month window.

The last Dow Theory buy signal was posted in early 2003 when both the Dow industrials and the Dow transports broke above their previous trading peaks. We now need to examine the Dow Theory model and see if a sell signal is probable."

Why the concern? The Dow transportation average is about 400 points under the 5,014 peak posted on May 10, 2006. The Dow is at all time highs.