A Century-Old Technique for Analyzing the Market Is Raising a Warning for Investors

Rising Railroad Shipments Show U.S. Expansion Gaining

Cargo passes on a Union Pacific freight train near the J.R. Davis Yard in Roseville, California, U.S.

Ken James/Bloomberg

Transportation stocks are trailing the Dow Jones Industrial Average by the most in more than two years, raising concern among investors who follow a market-analysis technique that’s more than a century old.

The Dow Jones Transportation Average has fallen 4.8 percent this year as the industrial average climbed 1.2 percent, the biggest divergence over comparable spans of time since October 2012. The transportation gauge has lost almost 5 percent in less than a month and on Tuesday dipped below its average from the past 200 days for the eighth time since March 26.

The moves could be alarming to investors who subscribe to what’s known as Dow Theory, which holds that transportation and industrial stocks must advance together for market gains to last, said Richard Moroney, chief investment officer at Horizon Investment Services and a follower of Dow Theory, named after Wall Street Journal founder Charles Dow who came up with the concept in the 1880s. A drop in the Dow industrials to 17,164.95, the lowest closing level this year, would confirm a bearish trend, he said.

“Transports have gone below a key low and if the industrials were to confirm that by moving below that Jan. 30 close, that would be your classic bear-market Dow Theory signal,” said Moroney, who also edits the Dow Theory Forecasts and Upside newsletter. “It’s a yellow flag when there’s a divergence like this.”

The Dow industrials climbed 0.3 percent to close at 18,036.70 Tuesday. The transportation average slipped 0.1 percent as Norfolk Southern Corp., the second-largest railroad in the eastern U.S., tumbled 4.2 percent to lead losses after first-quarter profit declined and missed analyst estimates.

Sluggish Economy

While this year’s 1.2 percent gain in the Dow Jones Industrial Average may encourage bulls, the gap between the benchmark gauge and the performance of the railroad, trucking and airline companies that comprise the transportation average is widening. It’s a sign of a sluggish U.S. economy, according to Neil Azous, the founder of research and advisory firm Rareview Macro LLC.

“It’s confirming the weak economic backdrop of the first quarter that’s spilling over into the second,” said Stamford, Connecticut based Azous. “When you add that transportation signal into the rest of the data, the Dow Theory is not portending a bounceback in the data.”

Sales at U.S. retailers rose less than forecast in March after being depressed by harsh winter weather, signaling consumers are intent on not overextending themselves. The Standard & Poor’s 500 Index has added 1.8 percent this year, even as economic releases miss projections and analysts predict earnings will fall by 5.6 percent in the first quarter. The Russell 2000 Index of small-cap stocks is up 5 percent this year.

“The weakness in the transportation index is a very good leading indicator that suggests further underperformance in the Dow both on a relative basis to U.S. small caps and to international equities,” said Azous.

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