The Dow Jones Transportation Average (DJTA) has underperformed broad benchmarks since mid-July, when it turned sharply lower after hitting an all-time high. The three-week decline has dropped the instrument into the lower half of an eight-month trading range while raising red flags that could signal long-term tops for planes, trains and trucking companies. As a result, market players should watch key support levels, because breakdowns could generate profitable short selling opportunities while setting off aggressive sell signals in the broader market.

Airlines led transports to higher ground in the first half of 2017 but are now leading to the downside after major reversals in big domestic carriers including Southwest Airlines Co. (LUV) and Hawaiian Holdings, Inc. (HA). This bearish price action has dumped sector indices to three-month lows while dragging down relatively stronger multinationals including United Continental Holdings, Inc. (UAL) and American Airlines Group Inc. (AAL). (See also: American, Spirit a Buy on Q2 Sell-Off: JPMorgan.)

The downturn could signal trouble for the broader market because the sector's early cyclical components react to small but noticeable changes in economic supply and demand through shipping loads and passenger counts. Wall Street analysts have a notorious reputation for ignoring this group during big market turns because the contrary price action does not match up with their beloved spreadsheets.

The DJ Transportation Average Index Fund (IYT) completed a round trip into the 2008 high at $99 in 2011 and broke out into the triple digits in 2013, entering a strong trend advance that continued into the December 2014 high at $168. It then entered a volatile correction, descending in multiple waves that found support at $115 in the first quarter of 2016, while a two-step bounce lifted the fund back to resistance at the high right after the November election. (For more, see: Transport ETF Hits New 52-Week High.)

IYT has been testing that level for the past eight months, grinding sideways in a rectangular trading range between the upper $150s and lower $170s. A range breakout would establish a multi-year uptrend that predicts much higher prices, while a decline through range support would set off long-term sell signals. In turn, that bearish action could mark the next phase of a long-term top that eventually ends the transportation sector's multi-year bull market.

United Continental Holdings, Inc. (UAL) attracted unwelcome attention earlier this year following a video of a violent passenger confrontation that went viral on the internet, nearly forcing CEO Oscar Munoz to resign. The company and shareholders breathed a sigh of relief after boycott threats failed to materialize, allowing the stock to resume mixed price action that is nearly identical to that of its rivals. (See also: United Air Shares Slide on Outlook for Passenger Unit Revenue.)

The stock ended a multi-year rally near $75 at the start of 2015 and entered a persistent trading range with support in the upper $30s. The second breakout attempt in two and a half years failed in July 2017, giving way to a major decline that has dropped the price below the 200-day exponential moving average (EMA), while on-balance volume (OBV) confirms the most aggressive distribution since 2014. The stock is now building support near $65 and should turn higher soon, testing new resistance between $73 and $75.

The monthly stochastics oscillator reached the overbought level at the end of 2016 and has just entered a sell cycle that predicts six to nine months of relative weakness. This is likely to generate a stiff headwind during the next recovery effort, which could dictate price action well into 2018. Specifically, a lower high could attract major selling pressure that drops the stock into a test at multi-year range support in the lower $30s, with a breakdown signaling a bear market that could spread throughout the airline sector. (To learn more, see: Stochastics: An Accurate Buy and Sell Signal.)

The Bottom Line

Transportation stocks have been sold aggressively since the start of second quarter earnings season, signaling a major bearish divergence that could mark the start of a broader correction. Informed market players will watch 8,880 on Dow Jones Transportation Average and $158 on the index fund because a breakdown at those levels could send benchmarks into a tailspin. (For related reading, check out: How to Analyze the Transportation Industry.)

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>

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