Is Dow's Divergence A Problem?

01/23/2013 11:30 am EST


Thomas Aspray

, Professional Trader & Analyst

For most of 2012, weakness in the Transports vs. the greater stock market was a concern, but now that it’s the other way around, MoneyShow’s Tom Aspray explores what this switch might be signaling now.

Many in the financial press since have focused on the ability of the Dow Transportation Average to finally surpass its all time highs from May 2008. I follow the Dow Jones Transportation Average quite closely as it is one gauge I use to determine the overall health of the stock market.

The divergence between the Dow Industrials and the Dow Transports had me concerned last September, One Sector Sends a Strong Warning, as I knew the participation of the Transports was needed for a truly healthy market.

Finally in December, the Dow Jones Transportation Average broke out of its trading channel and the relative performance analysis suggested that IYT was now starting to lead the S&P 500.

Since the middle of last month the iShares Dow Jones Transportation Average (IYT) is up 10.5% while the SPDR Diamond Trust (DIA), which tracks the Dow was only up 4%. The Spyder Trust (SPY) over the same time period has gained 4.9%.

The Dow Industrial Average is still 3.5% below October 11, 2007 high of 14,198, so should investors be concerned?

Click to Enlarge

Chart Analysis: I have found that one of the cleanest ways to compare the two market averages is to look at the weekly close only charts.

  • The chart of the Dow Industrials shows what may be a rising wedge formation, lines a and b.

  • This is a potentially negative formation but it would take a weekly close below 12,815 to turn the chart negative.

  • The upper boundary of the formation is at now at 13,935.

  • The upside breakout in the Dow Transports makes the next upside target at 5866, which is the quarterly R2 resistance.

  • The first good support is now at the May 2008 high.

The weekly chart of the iShares Dow Jones Transportation Average (IYT) shows the breakout of the trading channel, lines c and d, which preceded it’s upward acceleration.

  • IYT is already close to this week’s starc+ band at $102.90 with the monthly starc+ band at $105.74.

  • Looking at the trading range between the 2011 high and the 2011 low, the 127.2% Fibonacci target is at $110.

  • The RS line has continued to rise sharply after breaking its downtrend, line e, in December.

  • Volume was strong last week and the downtrend in the on-balance volume (OBV), line f, was broken in early January.

  • The rising 20-day EMA is now at 5521, which is 4% below Tuesday’s close.

NEXT PAGE: 2 Attractive Stocks in an Attractive Sector


Click to Enlarge

Kansas City Southern (KSU) is a $10 billion dollar freight railroad company that also provides limited passenger service. It completed a flag formation in early 2013.

  • It has surged to new highs this week and is not far below its weekly starc+ band at $92.70.

  • The quarterly R2 resistance is at $94.44 with the upside targets from the trading range in the $96 area.

  • The relative performance broke out to new highs ahead of prices as it moved above its resistance at line c.

  • The RS line continues to look strong.

  • The weekly OBV has also made new highs and led prices on the upside.

  • It is well above support at line d.

  • There is initial support now at $87.40-$89.40.

Trinity Resources Inc. (TRN) provides service to the energy, industrial, and transportation industry but is considered part of the Railroad industry group because of its Rail Group.

  • The weekly chart shows that it completed a major triangle formation, lines e and f, in the middle of December.

  • This is a massive continuation pattern that has upside targets in the $50-$55 area.

  • The relative performance has confirmed the price action as it overcame its downtrend, line g.

  • The RS line is still well above its rising WMA.

  • The OBV broke out to new highs in August 2012 and has made further new highs in the past few weeks.

  • The OBV has long-term support at line i.

  • There is initial support at $36.85 with stronger at $35.80-$36.20. The quarterly pivot is at $34.45.

What it Means: The rally in the transportation average appears to be fairly strong and a recent article in the WSJ discussed the increased demand for rail cars even by some of the energy companies. This would support a more positive outlook for the economy.

For the stock market it would further strengthen the intermediate term if the Dow Industrials can also make a new closing high along with the Dow Transports.

The longer-term patterns for Trinity Resources Inc. (TRN) are very positive and suggests it has some good long-term potential but a setback is needed to buy.

How to Profit: For Trinity Resources Inc. (TRN), go 50% long at $36.66 and 50% long at $36.12, with a stop at $33.82 (risk of 7%)

Portfolio Update: For Kansas City Southern (KSU), you should be 50% long at $85.18 as the second buy level at $84.32 was not hit. Use a stop at $84.43 for now.

For more on the relationship between the Dow Industrials and Dow Transports read 80-Year-Old Wisdom That Still Works.

  By clicking submit, you agree to our privacy policy & terms of service.

Related Articles on STOCKS