×

This classic theory predicts incredible upside for stocks

Another day, another record.

Both the S&P 500 and the Dow Jones Transportation Average traded at record highs on Tuesday after revised GDP data showed the economy grew faster than expected in Q3.

Based on one of the oldest theories of technical analysis, this is significant. Dow Theory holds that a bull market in the transportation sector confirms bullishness for the rest of the market.

And the Dow Transports aren't just in a bull market, they're soaring even compared to the S&P 500. While the broad market index is up almost 12 percent year-to-date, the transports have enjoyed an astounding return of 24 percent.

"It is suggesting that equities have further to rise," said Ari Wald, head of technical analysis at Oppenheimer & Co. "When the Dow Jones Transports outperformed, it tends to be in the early to middle innings of a secular advance. So in terms of a secular outlook for stocks, we've got further to go in the years ahead."

To prove his point, Wald looked at an 85-year relative chart of the Dow Transports versus the S&P 500, using theoretical prices for periods before the S&P 500 was established. When the chart rises, it indicates that transports are outperforming.

Wald then overlaid that chart with one of the S&P 500 itself. Doing so, he noticed a pattern: When the relative chart of the Dow Transports had huge moves up over the span of a decade or two, the S&P 500 made subsequent upward moves lasting decades, as well.

"Transports outperformed from 1938 to 1953," said Wald. "The secular advance in the S&P 500 continued until 1966. Another big transports run was from 1973 to 1989. That S&P 500 secular advance continued until 2000. So when you add it up, I think the advance is intact, and I think transports have further to run, as well."

Here's where it gets really interesting: The relative price of the Dow transports just made peaks not seen since the mid-1930s.

"What's actually completed is an 80-year, head-and-shoulders bottoming pattern," said Wald. "There is a lot of momentum behind transports. I think they continue to lead stocks higher."

However, the fundamentals suggest there's more at play than just a booming economy, according to Gina Sanchez, founder of Chantico Global.

What's driving transports higher is a decrease in gas prices, she said. That "leads to better transport performance, but not necessarily purely because of sales. In fact, people have been very slow to spend this time around. The propensity to save has been high in this particular recovery."

Though Sanchez acknowledges the economy is in a recovery, she believes it's tepid.

"I'm still in equities," added Sanchez, a CNBC contributor. "I'm still recommending equities to my clients. However, I am tempering that with the fact that partially, there is nowhere else to be."

-----
Follow us on Twitter: @CNBCNumbers
Like us on Facebook: facebook.com/CNBCNumbers