Stages Of A Bull Market Part III: Confirmation

Includes: DIA, IYT
by: Gary Jakacky

This the third article in a series about how investors can look for clues, which might suggest a bull market should continue -- or may be nearing an end. You can find part one here and part two here.

You don't have to be following the financial news for very long before you see some analyst express concern that "the transportation stocks have not confirmed the recent market action of the industrials." Back in 2012 there was so much chatter about "confirmation" on the front pages of business sections you'd think Wall Street had been hosting a Papal Enclave of Catholic bishops from around the world.

Confirmation, in the financial sense, dates way back to Dow Theory, the granddaddy of all "technical analysis." Even here, there is some misunderstanding. Dow Theory is fundamental analysis, not technical. Why do I say this? Permit me to rephrase Charles Dow when he states the reason why confirmation is important:

  • If manufacturers' profits (and thus, their stock prices) are rising, it is because they are producing more. In order for these goods to be sold, they must be transported to markets where consumers can buy them.

Thus, the Transportation stocks (in Dow's day, the 1890s, this meant the "Rail Roads") have to chug along with a rising Industrial Average in order for the economy to be truly expanding, and, implicitly, the bull market to continue. Those are fundamental concerns about the economy: not simply technical "trendlines" or other bizarre indicators.

So what was the big to-do about in 2012? Simple: the Transportation average refused to advance to new highs for twelve agonizing months, while the Dow Jones Industrials went from strength to strength. Look at their eponymous ETFs: The SPDR Dow Jones Average (NYSEARCA:DIA) was solid in 2012... Not so the iShares Transports (NYSEARCA:IYT).


This performance disparity was one reason why many analysts were cautious about stocks (and economic prospects) as we entered 2013. Fortunately for us bulls, the disparity was resolved by the end of the first quarter of last year when the Transports finally rallied and joined their manufacturing/services cousins onto higher ground.

Since then there have been no "confirmation" issues. Zigs and zags higher in one index have been matched (not always at the exact same time) by the other. By this criteria, then, the cyclical bull market, which began in March of 2009, continues unabated.

So what should investors look for, if they need clues about when this bull market might end? Simple: a confirmed downtrend. Let's look at a good example from 2008, before the big crash.

In May of 2008, the Transportation Index rallied to a new high. Just barely, but in stocks as in horseshoes, close is good enough. However, the Industrials did not come close: they were well below their October 2007 highs in May of 2008. Look sharply at the two charts below and you can see this glaring discrepancy.

This lack of confirmation has to resolve itself: either both indexes go to new highs, or, sadly in this case, both averages go to new lows. Both averages had indeed gone to new lows by early September of that fateful year.

By this time, stocks had already dropped a noticeable amount. Still, the worst was yet to come.

If you see the market develop this schizophrenic behavior, take heed. A bear market may be lurking around the corner.

Disclosure: I am long SPY, XLV, IHI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.