A Possible Economic Red Alert

We have already remarked on the growing divergence between the Dow Jones Transportation Average (TRAN) and the Dow Jones Industrials Average (DIA) on previous occasions. These two stock averages marked the beginning of technical analysis as we know it today. Charles Dow compared the action in the averages over the long term and noticed that price divergences between them tended to develop close to turning points in the economy and the stock market. 

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Dow assumed that a marked upturn or downturn in one of the two sectors would soon be followed by a turn in the other sector. He essentially concluded that unless the two sectors were “confirming” each other, trouble was likely brewing under the surface. Over time, a set of technical trading rules was developed based on this observation, which is known as the “Dow Theory” today. To be sure, the Dow Theory is by no means providing fool-proof signals. However, a very large and long-lasting divergence between the two averages is usually not a particularly good sign.

Transportation stocks have steadily weakened since peaking at the last trading day of 2014. The DJIA by contrast has by and large moved sideways since then – click to enlarge.

No firm Dow Theory “sell signal” is in place yet, although one could perhaps regard the DJIA's dip in late June/ early July as a “minor” DT sell signal. Still, the divergence remains a noteworthy development, especially as it coincides with worsening breadth in the broader market (even in the technology sub-sector, as John Hussman points out in his most recent weekly market report).

However, what prompts us to write about this topic again is an article by Tony Sagami that was recently published at John Mauldin's site under the colorful title “Sinking Ships, Train Wrecks, and Empty Trucks: My Case Against Transportation Stocks”.