Money Making Opportunities in Transportation
Sector Watch: Taking Aim At The Record-Setting Dow Transports
by Jim Stanton, Technical & Quantitative Analyst
Monday, May 19, 2008
Since the Bear Stearns blowup on March 17, two stock indexes have clearly led the way ahead.
The first is the S&P 400 Midcap Index (^MID), which closed well above its 200-day moving average last week. It’s not entirely surprising that this index has performed well, given investors’ major wariness with large-caps in the wake of the Bear mess.
But the other strong performer is something of a surprise. Not only did it also close well above its 200-day moving average, it also made new all-time highs this morning.
I’m talking about the Dow Jones Transportation Index (^DJT). This is a remarkable feat, given the huge oil price runup to record highs, and the underperformance of airline stocks.
I’m going to dig a little deeper into this index today, using the ETF that represents it - the iShares Dow Jones Transportation Average (NYSE: IYT)…
Understand The Theory To Unlock The Profits
In order to understand the current movement of the Dow Transports - and where the index might go next - we need to apply a quick bit of theory. Dow Theory, to be exact…
Last week, all the stock indexes traded at new recovery highs. All except the most widely followed one, of course - the Dow Jones Industrial Average (^DJIA), which is trading just a few points shy of its May 2 high.
This creates a minor “Dow Theory” divergence. Simply put, this means that both the Dow Industrials and Dow Transports have to make new highs together in order for a bull market to stay intact. The same theory goes for a bear market - both indexes have to make new lows around the same time (allowing some time for the lagging index to catch up) in order for a bear market to continue. When one index does not confirm the other, within a reasonable amount of time, there is a good chance for a reversal in both indexes.
While you’ll find a few different interpretations of Dow Theory and how it triggers buy and sell signals, I prefer to use this simplest form of it to guide my analysis. So let’s get to it…
Dow Theory In Action
Since last July, we’ve seen a Dow Theory sell signal and Dow Theory buy signal on the Dow Industrials and Dow Transports.
The Sell Signal: The Dow Industrials went on to make new closing highs in October 2007, but the Dow Transports were lagging badly and set up a Dow Theory sell signal, which led to more than a 2,000 point drop in the Dow Industrials.
Over the final part of 2007, both indexes sold off and made new correction lows in late January. This signaled that they were still under a Dow Theory sell signal.
The Buy Signal: In mid March, the Dow Industrials made a new closing low for the year, but the Dow Transports fell well short of doing the same. As a result, the indexes reversed course, due to a new Dow Theory buy signal, which so far is still in force.
Dow Theory signals do not occur that often, but it’s well worth your time to check on them occasionally for potential reversal points. So with that in mind, let’s break down the Dow Transports a little more, using the index’s ETF…
Follow The Leader - The Dow Transports
I consider the Dow Transports to be a leading index indicator. For example, more often than not, it’s the index that creates the divergence (although I’ve seen it occur in reverse on more than one occasion, too).
This morning, IYT traded above its July 2007 high, which is also a record high for the stock. Having run some analysis through my ESP Profit System trading platform, the next intermediate-term upside target for the stock is up around $107.85.
However, since we’re dealing with a weekly chart, it could take weeks (and possibly longer) for IYT to reach its resistance area.
But here’s the thing: Because the Dow Industrials are currently more than 8% below their October highs, the Industrials will have to play catch-up in order to avoid another Dow Theory sell signal.
However, as long as the Dow Industrials are moving higher, or even go into a sideways consolidation pattern, without triggering a daily sell signal, we have to allow some time to confirm the move. In this case, it could take a matter of weeks.
Shorter-Term Outlook
As I mentioned, there is a minor Dow Theory divergence in place at the moment. But if the Dow Industrials can trade above 13,133 - its May 2 high - the rally should continue. In addition, because the S&P 500 and NYSE Composite are at new recovery highs, the Dow is likely to follow suit.
However, if it fails to get above 13,133, and instead closes below its uptrend line around 12,860 (the line drawn off the March lows), be very cautious. A move below 12,715 would trigger a minor Dow Theory sell signal.
Bear in mind that because some of the indexes have rallied over 20% since the mid March lows, they’re getting overbought, so we’ll probably see a more meaningful correction once the rally runs out of steam.
Until next time…
Jim Stanton
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