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'Dow Theory' doubters need to look at the data

A CSX train seen at the Norfolk Southern Bellevue Terminal in Bellevue, Ohio.
Justin Solomon | CNBC

A debate playing out every day lately among Wall Street strategists is about whether investors should worry that shares of transportation companies, barometers of the health of the economy, are falling.

Don't fall asleep yet. The century-old "Dow Theory" may still matter in this world now dominated by advanced technology and social media stocks, history shows.

S&P 500 vs. Dow transports YTD

The theory proposes that when the Dow Jones transportation average does not confirm a new high by the Dow Jones industrial average and begins to fall, then the industrials too will eventually decline. The reason why is that the underlying economic weakness auto, railroad and airline stocks are signaling in the present time will soon reveal itself to all investors soon.

Recent studies debunked transport stocks as a leading indicator. But it may be a coincident indicator.

CNBC Pro, using quantitative tool Kensho, looked at all the times in the past 10 years when the Dow Jones transportation average fell more than 5 percent in 30 days, as it has in the last month. We then looked at what happened to the broader market index—the S&P 500—during that same 30-day window. It's occurred 31 times over the last 10 years.

What's telling is that the S&P 500 fell on 81 percent of those occasions.

What's more, the average loss matched the Dow transports' fall exactly, at 5 percent.

That's not what's happening right now in trading through early Tuesday morning. The Dow transports are off by 5.5 percent in one month, while the S&P 500 is down just 1.8 percent.

In the chart, one can see the gravitational pull on the broader market.

Mark Luschini, chief investment strategist at Janney, said in an email:

"While the theory is not infallible it does make fundamental sense. The transports are evidence of business activity and share prices discount a forward looking assessment of economic growth ... the Transports and other market internals like breadth, as a gauge of the stock market's health, seem to have the sniffles."

So the two don't usually diverge like they have and it should be a cause of concern.

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To be sure, as with any market statistics, there's another side of the debate. Longer term, if one looks 13, 26 and 52 weeks out following transport underperformance, the S&P 500 is higher on average, according to data from Oppenheimer.

One could argue, however, that the stock market typically goes up over time so the Oppenheimer data are not exactly the best way to look at it.

Bottom line: in the short term, it's very likely the S&P 500 should converge with the transports and weaken in the short term. For the longer term, it's anyone's guess.

Disclosure: NBCUniversal, parent of CNBC, is a minority investor in Kensho.