Dow Jones Industrial versus Dow Jones Transports

Dow Theory conventionally holds that moves higher in the Dow should be validated or confirmed by matching moves in the Dow Transportation Average. When divergences between these two indices occur, it is something that one wants to generally take note of. It does not always signify a market reversal but the signal is reliable enough that only the foolhardy would ignore it.

The first chart is of the Dow Jones Industrial Average. Note how it is well above its 50 day moving average and has been since the start of this year. 

Next is a chart of the Dow Jones Transports. Quite a difference between the two charts is there not? On Wednesday of this past week, the Transports fell below their 50 day moving average for the first time this year. Thursday saw the index remain below it also. Friday, the late session recovery pulled the Transports back above the moving average effectively preventing a further deterioration. However, this weakness in the Transports needs to be monitored as it could be a precursor to further weakness in the broader stock market.

The rationale behind the Dow Theory is quite simple - the Transports basically include the stocks of those companies involved in moving things. If the economy is humming along, things are moving and lots of them. That tends to bolster the profits of those companies involved in the transportation of goods which feeds into higher stock prices for that sector. That confirms or validates the move higher in the broader stock market.

I sometimes wonder if the shift in the nature of the US economy from that of a manufacturing based economy to more of a service based economy has tended to marginalize this formerly reliable connection somewhat. Still, with the weakness showing up in the Russell 2000 (see the chart posted on Friday) and with a growing number of corporations that make up the S&P 500 showing negative first quarter earnings guidance, I am growing increasingly concerned that we are going to see the US stock markets roll over into a deeper and more protracted move lower. Thus far price retracements have been very shallow and of short duration because the stock market bulls have tended to ignore just about everything negative and have chosen to focus exclusively on the $85 billion worth of QE3 and QE4 being pumped into the system by the Fed.

I shudder to think what we are going to witness next if this massive amount of money creation fails to stem the deflationary tide that continues to rear its head not only here in the US but globally. The problem has been and remains, EXCESSIVE LEVELS OF DEBT.

My belief is that unless one can suspend the laws of economics and invalidate everything we have ever learned from history, there is a point at which the Piper is going to have to be paid and no amount of Central Bank money alchemy is going to prevent it.