Dow transportation fails to confirm Industrials

<p>As stocks post their biggest daily declines since mid October on a host of factors (13% decline in Athens stock exchange on renewed Greek political […]</p>

As stocks post their biggest daily declines since mid October on a host of factors (13% decline in Athens stock exchange on renewed Greek political uncertainty, restrictions in China’s bond market and worse than previous announced contraction in Japan), we note a rare divergence between the Dow Jones Industrials Average and the Dow Transportation Average, known as the failure of the Dow Theory.

As the Dow Jones Industrials Average (DJIA) hit a new record high on Friday, the move was not confirmed by the Dow Transportation Average (Transports), as is required by the Dow Theory. The Dow Theory postulates that the Transports must “confirm” the moves in the DJIA in order for the existing trend to sustain momentum. A new high in the DJIA would need to be met by new highs in the Transports in order to confirm and sustain the broad trend.

The last time a failed confirmation had occured in the Dow Theory was in January 2014, when equities finished had their first negative Jnauary in five years.

Conversely, downward reversals occur when both averages experience sharp downturns at around the same time. Today, we have the worst of both cases according to the theory; i) lack of Transports confirmation on the highs; while ii) sharp declines occurring in tandem.

Whether this is a déjà vu from October, when stocks sold off ahead of the inevitable end of QE, which was announced later that month remains to seen. The article by Wall Street Journal Fed watcher Jon Hilsenrath raising the odds that the FOMC would remove “considerable time” phrase in reference to maintaining low interest rates from next week’s statement may be considered as a non-issue, but this can be underestimated. A renewed jump in the US dollar, and later by bond yields would be an uncomfortable reminder to commodities (mainly oil) and emerging markets, who are already worried about the rising cost of their USD-denominated debt.

Tonight’s release of China’s November inflation figures will show persistent deflation on the producer level and possibly a new 4-year low on the consumer level. With commodities beaten by a slowing demand and oversupply, a more prolonged weakening in the Chinese yuan will be inevitable next year. Once the CNY depreciates more than 5% against USD, deflation will no longer be a theoretical matter.

DOW TRAN THEORY Dec 9

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