#$tran

For someone who uses Dow Theory every single day, it’s not something that I write about much. I may indirectly reference certain tenets all the time, but rarely do I write specifically about the 130 year old Dow Theory. I think I pretty much laid it all out earlier this year in my post: 5 Things Every Investor Should Know About Dow Theory. The simple minded choose to stick to the Dow Jones Transportation Average and Dow Jones Industrial Average either confirming each other or diverging from one another. And while this may in fact be a one of Charles Dow’s tenets (although they were Railroads back then, not the Transports we have today), it does not even make it into my top 5 most important tenets.

The reason that, to me, the Dow Theory tenet regarding Transports and Industrials isn’t as important as many of the others is because it’s not designed to give buy and sell signals. It’s for trend identification. So while price is the most important indicator to recognize a trend, Dow Theory can certainly be used as a supplement to that. But it’s important to understand that it’s only that and nothing more. So while you might hear people saying that it’s a Dow Theory Buy or a Dow Theory Sell Signal, it’s not. The new highs we saw this week in the Dow Jones Transportation Average finally confirmed the new highs that we’ve already been seeing in the Dow Jones Industrial Average. So yes, it’s confirmation that stocks are in an uptrend. But I think you need to be ignorant at this point to not recognize that, yes indeed, U.S. stocks are and have been in an uptrend.

So let’s review. Yes the Dow Transports confirmed the highs from the Dow Industrials. So yes, we are in an uptrend. Does it mean it’s a buy signal? If you’re job is to create misleading headlines, then yes. For sure. However, if your job is to make money in the market, then no, absolutely not. In fact, there is zero evidence that suggests the Dow Jones Industrial Average does any better in the short-term after both Averages first close at new highs, thus confirming their uptrends. You can even dig a little bit deeper into the data if you’d like and you’ll find that stocks actually do worse over the next month on average (and median) after the Averages first confirm one another.

More Most importantly, let’s remember that I appreciate and certainly incorporate Dow Theory into my regular process. It very much works today. But it doesn’t mean that we need to turn it into something it’s not for the sake of page views and click bait. This particular Dow Theory Tenet of Industrials and Transports confirming one another is simply a supplement to price action to help identify trend. It is no different than a moving average or a trendline in that respect. These are all far seconds to price itself in the importance hierarchy of trend recognition.

In addition, I definitely recommend reading: 5 Thing Every Investor Should Know About Dow Theory to give you a better idea of the more important tenets, and also some of the others that I keep towards the bottom of my list, like volume.

The Transportation Index ($IYT) had a much tougher 2015 than the broader market.  Where the S&P 500 moved sideways all year the Transports drove lower the entire year.  2016 did not start any better.  Transports took a hard fall at the beginning of the year.  But they found a bottom in January, a tad quicker than the rest of the market.  

That gave hope for the transports to lead the market higher.  Bad news, that did not happen.  After a quick run higher through to early March they stalled and started to pullback.  And that is where they stand today.  S&P 500 and Dow Industrials making new all-time highs.  Transports lagging.  But there may be hope again for a push higher.

The chart above gives the clues.  The first thing to note is that pullback in January reversed at a 61.8% retracement of the major run higher from 2012.  This is a deep pullback and a classic technical place for it to reverse in a long term uptrend.  On a shorter timeframe then the run higher in 9 weekly bars to the upside in a row showed a strong move.  

The pullback following retraced about 61.8% of that move as well before reversing up again.  Now there are 3 weekly bars to the upside (the third in progress) and a Measured Move higher to about 8750.   Will it run another 9 week streak to the upside?  

Momentum indicators moved up to near bullish ranges on the first leg.  And they really have not reset much since.  The RSI is just above the mid line, within sight of the 60 level to turn bullish.  The MACD is holding near zero.  Early in the current week it is moving out of the Bull flag to the upside.  Continuation through Friday, and a weekly close over 8000 gives a lot of credibility to a second leg higher.  A shift into 2nd gear.  

I have been watching the Transportation sector the last few weeks.  Looking at it on a short term basis.  It appeared ready for a break out to the upside.  That may have ended Thursday.  Too soon to tell.  But the longer term picture has some interesting things to say.

The chart below of the monthly price action in the Transportation Average shows the potential for more short term negative price action but longer term upside.  The short term downside comes from two concurring technical views.  The Average completed an extended AB=CD pattern late in 2014 and is pulling back.  A typical target would be a 38.2% retracement of the the pattern and reversal as a show of strength.  Or a deeper retracement to 50% or 61.8% as a sign of some weakness to prevail.

The second is the Elliott Wave action that is building.  The Average completed an upside wave (iii) within wave III at the point D.  Since then wave (iv), a corrective wave has been building.  One of the principles of Elliott Wave analysis is that the two corrective waves are usually not of the same form.  So if one is flat the other tends to be steeper.  With wave (ii) flat it would be expected that wave (iv) would be steep.  So far it has been steeper that wave (ii).  

Another principle is that wave (iv) cannot retrace far enough that is falls within wave (i).  That still leaves a lot of room to the downside for wave (iv).  The 38.2% retracement drawn is a fair guess at where it may stop, but the 50% retracement is not out of the range.  

Then comes the good news.  Following wave (iv) is the last piece of the wave III to the upside.  And Elliott Wave principles suggest it will be between 1400 and 4300 points.  I know, quite a range.  I might look to a number, after wave (iv) is finished, that puts wave (v) above wave (iii).