Dow Theory

It was a summer to remember: Nothing special happened. However, it was one of the few summers in recent years that stock investors wouldn’t prefer to forget. The summers of 2007, 2008, 2010, and 2011 were all worth forgetting. The summer of 2009 was the previous good one for stocks, but it wasn’t worry-free. Neither was this summer, but there was nothing really new to worry about. Just the same old, same old.

Actually, there is something new to worry about. A Dow Theory divergence has developed between the Dow Jones Industrials and the Dow Jones Transportation indexes. The former rose to a new cyclical high of 13279 on May 1, slightly exceeding the previous cyclical high at the start of this year. So far, it’s failed to move higher, raising fears of the dreaded “double top.”

Contributing to the concern is that the DJ Transportation index hasn’t even bothered to retest the year’s February 3 high, let alone last year’s cyclical high, which also happened to be a record high. The theory is that if the transportation stocks aren’t confirming the strength in the stocks of industrials companies, then look out below.

I also like to compare the S&P 500 Industrials Composite index to the S&P 500 Transportation index. The former excludes Transportation, Financial, and Utility stocks. On August 17, it actually rose to a 12-year high. However, the latter has been flat-lining since the start of the year just below its record high of July 7, 2011.

I don’t see a major divergence here. It wouldn’t take much for both indexes to converge in a more bullish fashion. Besides, when we have a closer look at the S&P 500 Transportation index, we see a very interesting and somewhat unusual divergence between the two major industries in this index:

(1) The Railroads index, which accounts for 46% of the market capitalization of the S&P 500 Transportation index, rose to a record high in late August. It is up 8.2% ytd. The forward earnings of this industry rose to a record high in mid-August. The 2012 and 2013 consensus earnings estimates have held up well at record highs too.

(2) The Air Freight & Logistics index, which accounts for 50% of the S&P 500 Transportation index, has been weak this year. It is down 1.2% ytd. The forward earnings of this industry also rose to a record high in July, but has declined recently along with the estimates for 2012 and 2013.

The internal divergence within the S&P 500 Transportation Index between the Railroads and the Air Freight & Logistics stock price indexes as well as between the recent earnings estimates for the two makes sense. The US economy is chugging along relatively well. Rail car loadings of intermodal containers rose to a record high in August. On the other hand, global economic activity is slowing, and so is business for Air Freight & Logistics companies.

Today's Morning Briefing: Fiscal Fiascos. (1) What are they worrying about in London? (2) The future of gridlock. (3) Will the cliff be delayed until mid-2013? (4) Martin Feldstein wants to cap loopholes. (5) Washington’s attack dogs defend their special interests. (6) Norquist’s no-new-taxes pledge. (7) Did Ryan single-handedly scuttle Simpson-Bowles? (8) Ryan’s omission. (9) A curse on both their Houses! (10) Sperling’s spin. (11) Global manufacturing weakening. (More for subscribers.)