MARKETS

The Dow Transports had a big 2012 but the question remains whether that will continue and what the Dow Theory is telling us at the start of 2013, notes Richard Moroney of Dow Theory Forecast.

Stocks surged after Congress passed legislation that blocks most impending tax increases and postpones scheduled spending cuts, pushing the Dow Transports above their 2012 high of 5,368.93.

The Dow Industrials moved within 1.5% of their 2012 high of 13,610.15, and a close above that level would reconfirm the bullish primary trend under the Dow Theory.

With a close above 13,610.15 in the Industrials, we will be looking for opportunities to add to our equity exposure. However, we'd see a failed attempt at new highs in the Industrials as worrisome, as divergence between the averages around market highs often presages a correction. Our buy lists have 9% to 11% in a short-term bond fund, with the remainder in stocks.

Cyclical Strength
Confirmation-the idea that both the Industrials and Transports must reach new highs or new lows for a valid signal-is central to the Dow Theory. While nothing says both averages must reach new highs or new lows on the same day or even in the same month, divergence between the two averages often reflects uncertainty regarding the business outlook.

The Transports failed to confirm new highs in the Industrials on several occasions in 2012, and that is one reason we have kept a portion of our equity portfolios out of the stock market.

Throughout much of 2012, a breakout above 5,368.93 in the Transports would have been enough for a bull-market reconfirmation under the Dow Theory. But both the Industrials and Transports suffered significant corrections that ended in November, and only the Transports have rebounded to significant highs.

Amid all the back-and-forth regarding government policy, it's worth noting that the Transports tend to be a good barometer for the more cyclical parts of the US and global economy. Also, other cyclical barometers are showing similar strength:

  • Broader indexes of the transportation sector are near 52-week and all-time highs.
  • All major industry groups in the transportation sector have participated in the recent rally, with the crucial railroad, trucking, and airfreight groups at or near recent highs.
  • The Morgan Stanley Cyclical Index, an equal-weighted average of 30 economically sensitive stocks from more than 25 industry groups, is at 16-month highs.
  • The Russell 2000 Index of small stocks, which tend to be especially sensitive to the business cycle, is at all-time highs.

Conclusion
Strength in the Transports and other cyclical stocks is a positive, but a close above 13,610.15 in the Industrials is needed for a bull-market confirmation.

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