Transportation Index Hasn’t Derailed the Rally, Yet.

• Posted by DynamicHedge
• on August 30th, 2012

 

Back in the late 1800’s Charles Dow wrote a couple hundred editorials in the newly established Wall Street Journal.  Those editorials were compiled into a set of rules commonly referred to as the “Dow Theory”.  One of Dow Theory rules is that the stock market averages must confirm one another.  Back then this meant that the if the industrial average and the rail average were moving up together, a bull market was underway.  This was a pretty simple tenant that left just enough room for interpretation.  It’s the interpretation of these indicators that can get people into trouble, including me.

In modern times, the rail index has been replaced by the transportation index ($TRAN) and the industrial average has been replaced with the S&P 500 index ($SPX).  It seems that people watch the relationship especially closely when a rally reaches an important patch of resistance — a wall, if you will.  If the transportation index is not trading in lock step with the senior indices when we reach a rough patch, then there must be a serious problem with the market.  In the aftermath of a crisis nobody wants to look stupid for not seeing the writing on the wall the second time — it’s almost like they’re worried.

Divergence is always observable in hindsight but in real-time it can just be lateness.  The transports have been a step behind for the last year and the market has continued to make new highs, albeit in very choppy fashion.  Is the transportation index refusal to trade tick-for-tick with the S&P 500 a sign of impending doom or is there something else we should be paying attention to?

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