Stop worrying about this ancient indicator

Oppenheimer's Wald: Don't fear the transports
Oppenheimer's Wald: Don't fear the transports   

It's one of the oldest stock market indicators: The Dow transports theory, which says that the performance of the Dow Jones transportation average ought to predict or at least confirm the performance of the market as a whole. And due to the prevalence of that theory, the recent underperformance of the transport stocks has caused some consternation among investors.

But Ari Wald, head of technical analysis at Oppenheimer, says it's a mistake to fret about the 8 percent slide the transportation index has suffered this year.

First, running a long-term historical analysis, Wald found that "Every time the transports underperformed over the last years, forward performance is better looking out the next year for the S&P 500 than when the transports outperformed over that period."

Specifically, after 52-week periods when the transports have underperformed, the S&P 500 has averaged gains of 2.2 percent, 4.7 percent and 9.4 percent in the following 13, 26 and 52 weeks, respectively (versus average gains of 1.4 percent, 2.4 percent and 4.3 percent over those time periods).

That implies, a bit oddly, that transport underperformance is actually a bullish indicator. But Wald sees the Dow transports as more of a "coincident indicator," given that the index "outperforms near tops" and "underperforms near bottoms."

The second problem with the transportation blues is that formally, the Dow transports indicator merely switches between throwing off "buy" and "sell" signals—and stocks still have the green light, as it were.

"This thing with this theory is that there are very clearly defined definitions that nobody listens to," Wald said in a Tuesday "Trading Nation" interview. "The signal has been on a buy signal since late 2011. To turn it to a sell, you need a failure for one of the indexes to make a new high, and a new high, and a breakdown for both. We have had the failure for the transports to make a new high, but actually as long as the industrials are holding above that January low at 17,164, it's still on a buy signal," Wald said.

Of course, the question of whether Charles Dow's theory about the relationship between the Dow transports and the overall market still holds remains an open one.

When the Dow Jones transportation average was created in 1884, it was called the Dow Jones railroad average, and held just nine stocks. Today, not only have railroads lost much of their import, but many major business don't rely heavily on shipping of any kind, or even on physical goods.

Naturally, then, the performance of transportation stocks can be expected to tell us far less about the overall economy.

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