Weekly Trends

Ryan Lewenza, CFA, CMT, Private Client Strategist

Should We Fear The Dow Theory Nonconfirmation?

May 29, 2015

Equity Market YTD Returns (%)

S&P/TSX Comp

2.7

S&P/TSX Small Cap

Dow Theory is a branch of technical analysis which examines the price action of
the Dow Jones Industrial Average (Industrials) and Dow Jones Transportation
Average (Transports). When the two indices are in uptrends and are both in
sync with each other it is a sign of market strength. Conversely, when the
indices are in downtrends or are diverging with each other, as is currently the
case, it can provide an early warning signal of a change in market trend.
The Transports have been weak as of late, with the index down 6.4% year-todate (YTD) versus the Industrials which are up 1.9%. More importantly, the
Transports broke below technical support of roughly 8,550, with many pointing
to this breakdown as a Dow Theory non-confirmation and a harbinger of
weakness ahead for the equity markets.

3.7

S&P 500

2.7

Russell 2000

3.5

MSCI World

4.8

MSCI Europe

18.3

MSCI EAFE

7.8

MSCI EM

5.6
-5

Canadian Sector

10

15

20

TSX Weight Recommendation

Consumer Discretionary

6.7

Overweight

Dow Theory is currently flashing an amber warning signal rather than a sell
signal based on the divergence between the Transports and Industrials. An
official Dow Theory sell signal would be generated if the Industrials were to
drop below 17,068. Until then, all we have is a non-confirmation which
requires close monitoring but is no reason to sell en masse.

Consumer Staples

3.6

Market weight

Energy

20.6

Market weight

Financials

34.8

Market weight

Health Care

6.1

Market weight

Industrials

7.8

Overweight

Information Technology

2.4

Overweight

Moreover, the preponderance of technical evidence remains bullish which

includes: 1) the S&P 500 Index (S&P 500) remains in a long-term uptrend and
above its rising 40-week moving average (MA); 2) market breadth remains
positive with the NYSE Advance/Decline (A/D) line making new highs; 3) global
equity breadth remains positive with numerous global bourses hitting new
highs; and 4) a number of market cycles we track are bullish for 2015.

Materials

11.1

Underweight

Telecom

4.7

Market weight

Utilities

2.1

Underweight

Level

Reading

Chart of the Week

Transports Diverge From Industrials Providing An Amber Warning Signal

Technical Considerations
S&P/TSX Composite

15,028.7

50-DMA

15,161.1

Downtrend

200-DMA

14,916.6

Uptrend

47.2

Neutral

RSI (14-day)
16,000
15,500
15,000

S&P/TSX
50-DMA
200-DMA

14,500
14,000
13,500
13,000
12,500
12,000
11,500

11,000
Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15

Source: Bloomberg, Raymond James Ltd.

Please read domestic and foreign disclosure/risk information beginning on page 5

Raymond James Ltd. 5300-40 King St W. | Toronto ON Canada M5H 3Y2.
2200-925 West Georgia Street | Vancouver BC Canada V6C 3L2.

Source: Bloomberg, Raymond James Ltd.

Weekly Trends

Dow Theory Non-Confirmation

After reading some recent articles on popular financial websites, one would think
that were in or nearing the early stages of a bear market, rather than a market
hitting new all-time highs. For example, the S&P 500 and MSCI World Index both hit
new all-time highs on May 21, which coincided with published articles titled A Stock
1
Market Top Is Likely Near As Investors Fail To Hedge and Countdown To The Stock2
Market Crash . To be sure, we also have some reservations about the stock market,
ranging from lofty valuations, unsustainably high profit margins and record margin
debt levels; however, we maintain our constructive view on equities given two
crucial factors. First, the current not too hot, not too cold economic backdrop is
very supportive for equities as inflation remains low, allowing central banks to
maintain accommodative policies while continued economic growth supports
corporate earnings growth. Second, the North American (NA) equity markets remain
in long-term technical uptrends. Currently, the big story making headlines is the
divergence between the Industrials and Transports, which has resulted in a nonconfirmation. In this weeks publication we examine Dow Theory, and provide our
take on this non-confirmation between the Industrials and Transports.
Dow Theory is a branch of technical analysis which examines the price action of the
Dow Jones Industrials and Transports. The theory, popularized roughly 100 years
ago, has two central tenets. First, it helps define whether the US equity markets are
in uptrends or downtrends, with a focus on primary trends (i.e., long-term). Second,
it looks at whether the two indices are in sync with the Transports confirming
the Industrials. The underlying premise of Dow Theory is that if goods are being
produced (i.e., Industrials) then the goods need to be shipped (i.e., Transports) and
that both indices should be in uptrends, which is a sign of market strength.
The Transports have been weak as of late, with the index down 6.4% YTD versus the
Industrials which are up 1.9%. The weakness in Transports has been driven by
declines in the airline and railroad stocks (see sidebar). Below we chart the
Industrials with the Transports to illustrate the divergence. As the Industrials have
trended modestly higher since April, the Transports have been trending lower. More
importantly, the Transports broke below technical support of roughly 8,550, with
many pointing to this breakdown as a non-confirmation and a harbinger of
weakness ahead for the equity markets. However, we believe its way too early to
make this call, and as such, we maintain our bullish technical view of the equity
markets.
Dow Transports Breakdown And Diverge From Industrials

Source: Bloomberg, Raymond James Ltd.

1. http://www.marketwatch.com/story/a-stock-market-top-is-likely-near-as-investors-fail-to-hedge-2015-05-19
2. http://www.marketwatch.com/story/stock-market-crash-of-2016-the-countdown-begins-2015-02-25

May 29, 2015 | Page 2 of 4

Dow Transport Returns

03/20/15 to 05/26/15
Company
UNITED CONTINENT
SOUTHWEST AIR
KANSAS CITY SOUT
CH ROBINSON
NORFOLK SOUTHERN
UNION PAC CORP
DELTA AIR LI
AVIS BUDGET GROU
CON-WAY INC
LANDSTAR SYSTEM
ALASKA AIR GROUP
HUNT (JB) TRANS
EXPEDITORS INTL
RYDER SYSTEM INC
MATSON INC
CSX CORP
UNITED PARCEL-B
JETBLUE AIRWAYS
FEDEX CORP
KIRBY CORP

Industry
Airlines
Airlines
Transport-Rail
Transport-Services
Transport-Rail
Transport-Rail
Airlines
Rental Auto/Equip
Transport-Truck
Transport-Truck
Airlines
Transport-Truck
Transport-Services
Transport-Services
Transport-Services
Transport-Rail
Transport-Services
Airlines
Transport-Services
Transport-Marine

Source: Bloomberg, Raymond James Ltd.

Return
-25.2%
-22.3%
-19.1%
-16.5%
-14.4%
-12.4%
-11.7%
-11.1%
-9.9%
-9.2%
-9.2%
-5.9%
-5.6%
-4.5%
-2.2%
-1.1%
0.3%
0.4%
1.2%
2.9%

Weekly Trends

May 29, 2015 | Page 3 of 4

Why Were Still Technically Bullish

Currently, Dow Theory is flashing an amber warning signal rather than a sell
signal based on this non-confirmation of lower lows on the Transports and new
highs for the Industrials. An official Dow Theory sell signal would be generated if
the Industrials were to reverse and drop below 17,068 (December lows), which
would result in a lower low and confirm the new lows on Transports. Until then all
we have is a non-confirmation which requires close monitoring, but is no reason to
sell en masse. Moreover, the preponderance of technical evidence remains bullish
which overrides the current amber warning from the Transports. Bullish technical
trends include:

The S&P 500 remains in long-term uptrend with the index trading above its
rising 40-week MA. We rely heavily on longer term moving averages, such
as the 40-week MA, as they capture the long-term trends which are the
basis of our strategy and asset allocation work.

Market breadth remains positive with the NYSE A/D line making new highs,
thus confirming the new price highs for the US equity markets. Strong
market breadth signals a healthy stock market, where gains are broadbased, rather than a select number of stocks or sectors driving the overall
market higher.

Breadth is also positive from a global perspective, with many global bourses
recently making new highs (e.g., Stoxx 50, Nikkei and Shanghai Index).

Finally, a number of market cycles we track are bullish for 2015. They
include: 1) the Presidential Cycle (bullish in year 3 of a US Presidents term);
2) US midterm elections (since 1945, the S&P 500 has posted a positive
return in every subsequent 12-month period following a midterm election);
and 3) the Decennial Cycle is bullish for years ending in 5.

Conclusion
We have been dumbfounded by the chorus of bears who have repeatedly
prognosticated the end of the current bull market often citing arcane valuation
metrics and/or technical observations, such as the current non-confirmation of the
Dow Transports. While the current divergence between the Transports and
Industrials is something to closely monitor, it is a secondary indicator to price, which
we put more weight in. Until we see a long-term breakdown of the current uptrend,
we will maintain our bullish view, which has served us nicely in recent years.

S&P 500 Remains In A Long-term Uptrend

Rising A/D Lines Capture Positive Market Breadth

92,000

2,100

1,900

82,000

1,700
1,500

72,000

1,300
62,000

1,100
900

52,000

S&P 500
40-Week MA

700

NYSE Advance/Decline Line (LHS)

500
'05

'06

'07

'08

'09

'10

Source: Bloomberg, Raymond James Ltd.

'11

'12

'13

'14

'15

42,000
Jan-13

Jul-13

Jan-14

Jul-14

Jan-15

Weekly Trends

May 29, 2015 | Page 4 of 4

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