What’s not to like about Dow 13,000? While most investors cheered when the blue-chip index closed above that level Tuesday for the first time since May 2008, some were wringing their hands. The Dow Jones industrial average has left the Dow transportation average behind, and that could mean trouble.
“There’s a risk that stocks could slide,” says Bruce McCain, chief strategist at Key Private Bank. Adds Dennis Slothower, editor of the investor newsletter Stealth Stock Daily: “When the Dow leads everything else, that’s not a healthy sign.”
The rap on the Dow is that it tracks the biggest, most financially stable companies. Technical analysts, who study previous stock movements to anticipate future ones, say you have to look at other indexes, too.
Take the Dow Jones transportation average, the granddaddy of indexes, which traces its origins to 1884. It tracks railroads, shipping companies and airlines – the businesses that move people and goods through the economy.
This collection of 20 stocks fell 3 percent in February, counting reinvested dividends, while the better-known Dow Jones industrial average rose 2.5 percent. Since last April, the high for most indexes last year, the transports have dropped 6 percent, compared with a 1.2 percent gain for the Dow.
Technical analysts say that if one index reaches a high and the other doesn’t, that means the rally could falter. They say that’s what happened before stocks tanked in 1929, 1937 and 2000.
The analysts disagree over how much to worry now. And the Dow is not the only index climbing fast. A day after the Dow closed at 13,005, the Nasdaq composite index of technology stocks briefly broke through 3,000 for the first time in 11 years.
Still, there are worrisome signs besides transportation stocks that the rally may not last:
- The price of gas is up, too. The average for a gallon of unleaded is $3.74, the highest on record this time of year. Some investors believe gas prices are the biggest threat to the rally because when people pay more at the pump, they often spend less elsewhere.
- The Russell 2,000 is still off its high. The popular index of smaller stocks, the kind of iffy outfits that surge when investors feel like taking big risks, has rallied 8 percent this year but is still 6 percent below its high of April 29.
- Traders are scarce. About 4 billion shares are trading every day on the New York Stock Exchange, compared with about 4.4 billion last year. That suggests investors aren’t buying with much conviction.
- Main Street still isn’t bullish. Investors pulled $137 billion from U.S. stock mutual funds from last June through January, according to Strategic Insight, an industry consulting group.
Technical analysts watching the transportation average for signals to buy or sell can make your head spin with their talk of “head and shoulders patterns,” “Fibonacci retracements” and “resistance areas.” But even investors who usually talk in normal English have taken note of the lagging index lately and lapsed into techno-speak.
A day after the Dow hit 13,000, David Rosenberg, the normally lucid chief economist at Gluskin Sheff & Associates, put out a report noting the recent “nonconfirmation” signal from the transportation average. A few days earlier, the folks at research group Bespoke Investment wrote a note to clients pointing out the “negative divergence” themselves.
Translation: Watch out.
Investors trying to guess where stocks are heading like to follow the transports because if consumers and businesses are buying more, then all those goods have to be trucked, shipped and flown somewhere, and stocks should be rising.
Technical analysts like to see them rising together with the Dow industrials, and the two hitting highs together. When one hits a high, and the other lags, the technical crowd sees trouble.
That’s the gist of the so-called Dow theory, a venerated gauge of when to buy and sell named after Charles Dow, co-founder of The Wall Street Journal. He came up with the first average of 11 railroad and shipping companies, including the once mighty Pacific Mail Steamship Co.
You’d think a measure devised when Chester A. Arthur was president and men walked around with mutton-chop sideburns would have lost its appeal by now. But the index has provided a clue to some big turning points in the market, or so its fans say.
Not everyone is not convinced that we’re at a turning point now, and that the rally could falter.
Fred Meissner, the writer of the Fred Report, an advisory service for technical investors, doesn’t think so. He says the transports, far from lagging the Dow in hitting a high, are actually leading the Dow.
It depends, he says, on how you define lagging and leading. He thinks the two indexes are basically hitting highs together. The transports just hit their high earlier – an all-time record of 5,618.25 last July.
“I would be buying stocks here,” he says.
If you find this a bit confusing, there are plenty more straightforward reasons to be optimistic. For starters, stocks are trading at 13 times their estimated per-share earnings for the coming year, cheap compared with the typical 15 times.
Then there’s the strengthening U.S. economy. Layoffs are at a four-year low. On Thursday, retailers supplied more good news: Sales in February compared with a year earlier were up a surprising 6.7 percent.
Still, it doesn’t hurt to keep an eye on transports. Slothower of the Stealth Stock Daily say he’ll hold on to his stocks, but if the index drops below its average close over the past 200 days of 4,954, just 4 percent lower than Friday’s close, all bets are off.
“People are being more defensive,” he says. “That’s not a good sign.”