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Mark Hulbert

Meaning of weakness in Dow transports

8/10/12 12:01 AM ET (MarketWatch)Print

CHAPEL HILL, N.C. (MarketWatch) -- The real story in the stock market is, as usual, being played out off stage.

That's because all eyes have been diverted by the drama being played out by the Dow Jones Industrial Average (DJIA) : Would it, or would it not, close above its May 1 bull market high of 13,279.32?

For a maddeningly long stretch of sessions now, the benchmark has flirted with that high -- coming close and, ultimately, falling short. The Dow got within 64 points on Tuesday, for example, and within 79 points on Thursday.

Yet take a look at the Dow Jones Transportation Average. It is more than 5% off its early May highs, and more than 10% off its bull market high that was set more than a year ago -- in July 2011.

There are at least two reasons to take the Dow transports' weakness seriously. The first is that many claim that the transportation sector often acts as a leading indicator of the overall economy.

There are of course a myriad of things that Wall Street analysts will, at different times, allege to be leading indicators. And most of them fail to withstand statistical scrutiny.

But there appears to be at least some objective support for the notion that weakness in the transportation sector can presage weakness in the overall economy.

Consider a study conducted by the Bureau of Transportation Statistics in the U.S. Department of Transportation, which analyzed the bureau's Freight Transportation Services Index. The researchers found that their index is indeed a useful leading indicator -- turning down an average of four to five months prior to slowdowns in the economy. ()

The other reason to take seriously the pronounced weakness in the Dow transports: It is one of the two Dow averages on which the venerable Dow Theory is based. Only new highs that are jointly hit by both averages are considered evidence of a healthy bull market.

To be sure, not all Dow Theorists see eye to eye right now on whether the Theory is on a buy or a sell signal. But they all agree that the transports' weakness is of concern.

Those who are currently bullish consider the divergence between the industrials and the transports as a potentially worrisome sign, while those who are currently bearish point to the transports' weakness as a reason not to get excited, even if the industrials were to finally close above its May 1 high.

In any case, it's worth noting that the divergence between the industrials and the transports has been going on now for over a year -- a surprisingly long time.

Even if you're not inclined to follow the Dow Theory, I suspect that the bulls among you will breath a whole lot easier if and when the transports do finally decide to play catch up.