Is This 100-year Old Indicator Suggesting Market Strength?

The Dow Jones Industrial Average (Dow) gained for the sixth consecutive day yesterday and closed at a new all-time high for the third straight day. The Dow Jones Transports (Transports), meanwhile, had another big day yesterday and has been one of the top performers since the election. The Dow and Transports will forever be linked, as they are the two components to Dow Theory. Charles Dow created the Dow Theory in the late 1800’s, and it revolves around needing confirmation from both industrial and transports before establishing market direction. Think about it—if both the industrial and transports are strong, this likely suggests an improving economy. The flip side is if both are going lower, the economy is weakening.

Another way to look at the relationship between the two indexes is to compare them on a relative strength chart. When the ratio of the Transportation Index to the Dow increases, this means that transports are outperforming. We have found that when this ratio on a weekly chart moves above its 40-week simple moving average for more than three weeks, stocks tend to move higher over the next year. This signal triggered recently; the last time it happened was in late 2012, right before a huge equity rally in 2013.

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Looking at historical data going back to 1979, this signal triggered 20 times. Take note, we removed the two largest recessions over the past 20 years, as we don’t see any signs of a coming recession. The S&P 500 gained more than 9% on average six months later and was higher 80% of the time. Going out a full year, the S&P 500 has been up more than 16% on average and higher all 20 times.

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Could this newfound strength from the transports be telling us the economy could be set for strong improvement as we head into 2017? It very well could be, and this could be another reason to expect the equity bull market could possibly continue as well.

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.The economic forecasts set forth in the presentation may not develop as predicted. The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. Stock investing involves risk including loss of principal. Because of its narrow focus, specialty sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Dow Jones Industrial Average Index is comprised of U.S.-listed stocks of companies that produce other (non-transportation and nonutility) goods and services. The Dow Jones Industrial Averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors, and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore, their component weightings are affected only by changes in the stocks’ prices. This research material has been prepared by LPL Financial LLC.

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