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DOW Industrials vs DOW Transports, which one is lying?

Letter 1 of 2007 - 31 Dec 2006.

Now, apparently, if I was half way to becoming an ecobabble guru then about this time of the year I should be predicting what is going to happen to the markets in 2007. As I tend to do that on a forward looking 6-18 month timeline in my letters anyway, I thought I would look at something much more imminent instead.

We have been seeing alot of chat about Dow Theory recently, the rough idea is that a move upwards or downwards in DJ Industrials has to be confirmed by the same action in the DJ Transport index. Told you is was the rough idea.... if you want to get into the meat of Dow Theory I would suggest reading Tim Wood or googling the subject, there is plenty to read and I don't want to get into a discussion about its feasibility. For me its like EW, useful but not what I use to trade. I do, however look for divergences when trading and for me, thats what Dow Theory does the best, it shows up divergences.

Enough blah about what I do, what I want to show the post Christmas, jaded reader is just 2 things: dow theory should not be ignored and that either the DJIA or DJTI is lying. Now this does not mean that I am a DT guru, it just means I have spotted something that I think is important, you get my drift? So I have to ask you to just go with the flow on this, even if you think DT is bunkum.

The big question about the US mkts that we, the unwashed masses want to know is simple, are the new numerical DJIA highs the start of a new bull market or are we being led up the garden path and if we bought now would we be the last buyers, the muppets left holding as the charts make a dive that an Italian footballer (soccer in US parlance) would be proud of? We could allow ourselves to be influenced by all the official newswire stuff, it paints a comfortable picture, stops us having to think and gives lots of post event justification for why things happen. Or - we can start to exercise the mind and look for clues. So here are some clues and an answer to the big question.

I want to look at some charts, the DJIA, DJTI and one other.

With thanks to StockCharts.com and the ATA.

Divergences abound eh? The black vertical line on the ATA chart is the start point for the DJIA and the DJTI, just for reference. Lets clear up a few points we can all agree on. The DJIA set new highs out of the July bottom, taking out the previous high in May, the DJTI has not and seems to be "struggling" to go higher, indeed its made a series lower highs from its initial May high. A break below 4134 on a closing basis would set up a series of nasty looking lower lows too, I see nothing that says buy on the weekly chart right now. A move above the 50ma might make it look a bit better. The DJIA weekly chart looks to be near overbought, but its not showing a sell signal and can stay overbought for as long as it wants and still go higher. So we have a divergence, the DJIA sets new highs as it marches on, whilst the DJTI looks like its suffering a breakdown. But which, of the 2, is reflecting a truism? Have a good look (through those bleary, post New Years Eve suffering eyes) at the ATA tonnage chart and the DJTI. Bear in mind the ATA chart and information publication lags behind the TI by about a month, ie the latest info we have is for November.

It looks to me that Trannies tell the truth and is being priced for true economic performance, when compared to the companies who move the "stuff".

So, lets answer the questions.

Firstly The DJIA and DJTI are talking different stories. That can continue for awhile yet, or stop tomorrow (in other words, watch your back and your exposure to the markets). I will not be ignoring Dow Theory, especially when I can see that at least one of the components is telling the truth.

Secondly the DJIA lies, its performance is not reflecting economic truth. Again, this does not mean its about to collapse just because this ecobabbling half-guru has called it out, but I have no intention of becoming a muppet and getting sideswiped with the great unwashed. Its there to see, the DJIA is a liar and its fairly galloping up the garden path.

Finally (I heard that sigh of relief!) and most importantly, we may well have stumbled on a big clue. If we accept that Trannies tell the truth, then it and not the DJIA will give us a "heads up" call on what to expect.

I hope you enjoyed this letter, as usual I will set up a thread on Livecharts.co.uk for those who wish to discuss it further.


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