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Dow Theory Suggests Caution

By Mike Zaccardi, CFA, CMTMarket OverviewNov 21, 2022 05:18AM ET
www.investing.com/analysis/dow-theory-suggests-caution-200632612
Dow Theory Suggests Caution
By Mike Zaccardi, CFA, CMT   |  Nov 21, 2022 05:18AM ET
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  • The Dow Jones has sharply outperformed the Transportation Average
  • The former is on the cusp of breaking out above its August peak
  • The latter is well underneath its summer high
  • Technicians can easily spot this bearish non-confirmation as equities rise

The Industrials sector has powered the S&P 500 higher since early October. Much fanfare was made about the Dow Jones Industrial Average notching its best month since 1974, but technicians often like to look under the hood to see what’s driving price action. 

The past seven weeks or so have featured blue-chip multinational Industrials soar in price, much of the gains coming from positive earnings reports. Shares of Caterpillar (NYSE:CAT), Boeing (NYSE:BA), Honeywell (NASDAQ:HON), and 3M (NYSE:MMM) have provided years’ worth of gains over a handful of weeks.

S&P 500 Sector Performances Since October 6: Industrials Leading

S&P Sector Performance
S&P Sector Performance

Source: Stockcharts.com

Transports, while up impressively from their October low, are not quite as bullish as large-cap diversified indexes. That reality catches the attention of technicians everywhere. The century-old Dow Theory, among its six tenets, says that price indexes must confirm each other for a healthy trend to be in place. Right now, I see a decoupling between the DJIA and the Dow Transports.

Let’s start with the positive piece—the Dow 30. Notice in the chart below that the DJIA is comfortably above its 200-day moving average and making a run at the August high. The price-weighted index’s chart, with UnitedHealth (NYSE:UNH) as the biggest holding at more than 10%, looks better than so many other areas of the market. The last several sessions have the hallmarks of a bull flag pattern to me, implying the next move will be to the upside. But do the transports confirm that bullish outlook?

Dow Jones Industrial Average ETF: Above Its 200-DMA, Probing the August High

DIA Daily
DIA Daily

Source: Stockcharts.com

The answer is no. The above Dow Jones Industrial Average SPDR ETF (NYSE:DIA) chart contrasts with the iShares Transportation Average ETF (NYSE:IYT) in that the latter is well below its August high and failed again at rising above its 200-day moving average. Not even lower oil prices lately have helped the transports. Dow Theorists, and technicians more broadly, must monitor the August highs on both of these ETFs. We are in bearish mode, confirming the overall cyclical bear market, until new rebound highs on both the industrials and transports are made.

Dow Jones Transportation ETF: Below Its 200-DMA, Underperforming

IYT Daily
IYT Daily

Source: Stockcharts.com

So, the focus is on the transportation average, specifically. We can look for additional clues using historical seasonal patterns. According to Equity Clock, IYT often struggles somewhat against the S&P 500 now through early January. Despite this being a positive time on the calendar for much of the equity market, transports sometimes do not lead the way. They do, however, perform relatively well starting in early January through early May. It is one sign that some volatility could be on the horizon for the broad market which might be the contrarian take.

A Not-So-Cheery Time of Year for IYT Vs. the S&P 500

IYT Vs. S&P Weekly
IYT Vs. S&P Weekly

Source: Equity Clock

The Bottom Line

The Dow Theory waves a caution flag right now as the transportation average is sharply underperforming the DJIA. Bulls want to see alpha out of IYT to help give legs to the current rally.

Disclaimer: Mike Zaccardi does not own any of the securities mentioned in this article.

Dow Theory Suggests Caution
 

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Dow Theory Suggests Caution

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Comments (1)
gary leibowitz
gary leibowitz Nov 21, 2022 1:50PM ET
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This market is like the last 6 years of TRUMP. You either base your decision on facts or illusions.  A man that tried to overthrow this government and hang his own disloyal VP has been rewarded by  the most richest man in the world with a platform on TWITTER as others are permanently banned. the hypocrisy is as stark as this market. We see what we want and disregard the rest.  Just based on analytical earnings projections for 2023 the SPX has a fair value at 3000.  need i say more?
 
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