Courtesy of Pater Tenebrarum via Acting-Man.com
A Big Dow Theory Divergence
We briefly want to show a few charts that have caught our eye recently. This is by no means a comprehensive market update (we plan to provide one soon). Here is something though one doesn’t see all too often: the Dow Industrials and Transportation averages have diverged from each other for about six months running. To be sure, no valid Dow theory sell signal has been given yet. For that to happen both averages need to break their previous reaction lows in concert. However, divergences at peaks are a “heads up” signal. Charles Dow would probably at least raise one eyebrow and frown a little.
Transportation stocks have turned from leaders into laggards, in the process diverging ever more from the Industrials average – click to enlarge.
The NYA, Then and Now
The next two charts were sent to us by a friend who manages a fund and often passes on his technical observations to us. The first chart shows the broad-based NYSE Stock Exchange Index (NYA) as it looked in the final years of the tech mania that fizzled out in the spring of 2000. The second chart shows the NYA as it looks today.
The NYA from 1996 to 2000 – click to enlarge.
The NYA today – click to enlarge.
The similarity between these two charts is quite baffling. However, we hasten to add that we have seen many such pattern comparisons over the past few decades, and they often turn out to be meaningless. Incidentally though, Paul Tudor Jones’ career really took off when he traded the 1980s market based on the pattern of the 1920s market, and the pattern actually did repeat, including the infamous crash (the action obviously began to diverge after the crash, but the patterns eerily shadowed one another for a number of years). So at times, a pattern comparison can actually turn out to be helpful.
The wedge-like formation at the end of the respective moves in the NYA highlighted above with blue trend lines does look like it could be a so-called “ending diagonal” pattern. It certainly was one in 2000, whether the recent wedge will also turn out to be one remains to be seen of course. However, with sentiment and positioning data as well as valuations extremely stretched and US money supply growth rates slowing down, a similar outcome certainly shouldn’t be ruled out a priori.
Conclusion
The divergence between industrial and transportation stocks is probably the more meaningful of these charts, as there is a logical explanation as to why its occurrence is worrisome. Specifically, Dow argued that when business was good for industrial companies, it had to be good for transportation companies as well, and vice versa. Any divergences in the assessment of these businesses by stock market participants should therefore be seen as a warning sign.
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Editor's note: Also see the Reformed Broker's post "The New NEW Divergence "suggesting that our economy has changed and now the divergence between Dow Transports and the Dow Industrials may not be as meaningful as it used to be. It may not be sign of weakness to come in the overall market. Joshua Brown writes,
This week it’s the fact that the Dow Transports are setting multi-week lows while the Dow Industrials flirt with an all-time record breakout. Maybe this “non-confirmation” will matter. Hasn’t mattered about a hundred times before as this sort of divergence has resolved itself to the upside – crisis averted. But this time, maybe. Once upon a time, it was a major sign of a top – at the peak of the dot com boom, the trannies were getting crushed and never confirmed. In hindsight, “that was the tell! Classic!”
And then like every single time afterward it simply didn’t matter at all.
