June 25th, 2009

Transportation Stocks Might Soon Be Confirming Dow Theory

I haven’t written much about the Dow Theory because, quite honestly, while it’s a technical analysis sort of concept I don’t believe it to be stock charting the way I practice it.

Most consider the father of technical analysis to be Charles Dow, the founder of Dow Jones and Company publishers of the Wall Street Journal. In a series of papers around 1900, Dow described his belief that markets, as represented by the Dow Jones Industrial Average and the Dow Jones Transportation Index, tended to move in similar ways over time. Those papers, expanded by others in the years that followed, became known as “Dow Theory”.

The Dow Theory is usually broken down into the following six tenets:

  • First tenet: markets move in one of 3 trends – Up Trends, Down Trends and Corrections
  • Second tenet: trends have 3 phases -accumulation, public participation and excess phases
  • Third tenet: markets discount all news so that once a piece of news is released it is quickly reflected in price. [On this point Dow Theory is in line with the efficient market hypothesis.]
  • Fourth tenet: the Industrials and Rails Averages must confirm each other and if two averages moved in opposite directions it was a sign that the market was going to change direction.
  • Fifth Tenet: trends are also confirmed by volume.
  • Sixth tenet: trends exist until definitive signals prove that they have ended.

It’s point four, that Industrials and Rails must confirm each other, that I want to focus on because it’s the one most often mentioned by talking heads and the press. Also, there seem to be some interesting charts setting up in the various transportation Industry Groups that may point to a confirmation coming. IBD categorizes the many transportation stocks down into the following 7 Transportation Industry Groups:

  • Air Freight
  • Airlines
  • Transporation Equipment Manufacturing
  • Rail
  • Shipping
  • Transportation Services
  • Trucking

I previously wrote about the truck manufacturers, tires and replacement parts and heavy duty trucks because they all seemed to have begun performing extremely well (see “Truck Original Equip, Parts and Tires Under Green Light” from June 1). And now it appears that some of the above groups are also beginning to show some signs of life. Take, for example, the Rails, a group that’s still very low in ranking (150 out of 197), but one that’s begun climbing; its ranking has crossed above its 20-week moving average.

Two charts in that group that look interesting are:

  • UNP (Union Pacific)
  • CSX (CSX Corp)

Be prepared to hear a lot more over the summer about Dow Theory and the confirmation of the Industrials by the Transportation Index.

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