Dow Theory Could Signal Broad-Based Decline

The Dow Jones Transportation Average has failed to break out with major benchmarks, setting off a bearish divergence originally described by Dow Theory more than 100 years ago. This “non-confirmation” could be significant because it’s forecasting tougher times for blue chips and big tech in the second quarter. It’s even possible that the Dow Jones Industrial Average, S&P 500, and Nasdaq 100 are near, or have posted, their highest highs for the rest of 2020.

Along with small caps and energy stocks, transports are undermining typical market breadth readings expected during big bull runs. This shortfall adds another red flag into the mix, telling market players that first quarter gains have been limited to a select group of blue-chip giants rather than spread equally across the market universe. This type of price action is typical near the end of bull markets, although it’s not predictive without other types of confirmation.

Of course, the coronavirus outbreak is having a negative impact on transportation stocks, lowering airline income on highly profitable U.S.-Asia routes. The industry is already getting hit hard by the 737 MAX grounding, and this double whammy has the potential to generate massive losses. Unfortunately, the malaise could spread into other routes in coming weeks, underpinned by aggressive security measures taken by airports to quarantine infected individuals.

Taken together with the horror stories we’ve heard about cruise ship quarantines, many Americans and Europeans may just choose to stay home during the 2020 vacation season. The outbreak also has the potential to affect profits for truckers, railroads, and shipping companies, with supply chain disruptions lowering international trade volumes. The headwind may be greater than tariffs at this point, with both disruptions contributing to poor stock performance.

IYT Long-Term Chart (2008 – 2020)

The iShares Dow Jones Transportation Average ETF (IYT) topped out at $99.09 in May 2008, following a multi-year uptrend, and plunged during the economic collapse. It found support at a six-year low in the mid-$40s and turned higher into the new decade, completing a 100% retracement into the prior high in 2011. Price action then eased into a narrow trading rangecompleting the handle of a multi-year cup and handle pattern.

A 2013 breakout caught fire, lifting the fund through a graceful series of new highs into December 2014, when it topped out at $167.80. It turned sharply lower through 2015, carving an intermediate correction that posted a two-year low near $115 in January 2016. That marked a historic buying opportunity, ahead of a rapid advance that reached 2014 resistance after the presidential election.

Mixed price action completed a breakout in the fourth quarter of 2017, yielding a quick burst into January 2018’s high at $206.73. A September breakout attempt failed after posting an all-time high at $209.43, setting the stage for a fourth quarter swoon that hit a two-year low in the $150s in December. The 2019 bounce stalled at the .786 Fibonacci sell-off retracement level in April, yielding failed attempts to mount that barrier in July, September, November, and January 2020.

IYT Short-Term Outlook

While the long-term price pattern looks constructive, accumulation readings have barely budged since February 2019, despite multiple rally attempts. The monthly stochastic oscillator is generating similar action, wobbling through minor buy and sell cycles in the mid-section of the indicator. Taken together, it appears that apathy is a greater driving force for the transports at this point than bullishness or bearishness.

Unfortunately, this apathy has unfolded while major benchmarks have posted a long series of all-time highs, predicting that transports will fall faster and harder than blue chips during the next downturn. There isn’t much wiggle room on the downside for the transportation index because the 200-day exponential moving average (EMA) is sitting just seven points below the current price, with a potential breakdown setting off large-scale sell signals.

The Bottom Line

The Dow Jones Transportation Average has failed to break out, setting off a Dow Theory red flag that could presage much lower prices.

Disclosure: The author held no positions in the aforementioned funds or their components at the time of publication.