There's been a lot of talk about equity market breadth both in the U.S. and globally, but one thing I've not seen mentioned throughout the debate is Dow Theory. While there are five tenets of Dow Theory, today I want to focus on the aspect regarding confirmation among the three averages – the Dow Jones Industrial Average, Dow Jones Transportation Average and Dow Jones Utility Average – by assessing their primary trends.
Let's start off with the Dow Jones Industrial Average, which is trading at five-month highs and 4.20% below its all-time highs. From a structural perspective, momentum remains in a bullish range, the 200-week moving average is rising, and prices are still advancing in a series of higher highs and higher lows. There's not a whole lot of evidence that this is anything other than a secondary downtrend within a primary uptrend. (See also: Dow Theory.)
The Dow Jones Transportation Average is also hitting six-month highs and is just 2.30% below its all-time highs. Again, from a structural perspective, we're seeing much of the same that we saw in the Dow Jones Industrial Average. Prices hit an upside objective in January and have been consolidating since, now pushing back toward their highs. Again, a secondary trend followed by a continuation of the primary trend is very normal behavior.
The third relevant index is the Dow Jones Utility Average, which is hitting seven-month highs and is trading roughly 6.25% below its all-time highs. Last year, prices broke above the upside objective hit in July 2016 and failed to hold higher, confirming a failed breakout and correcting roughly 17%. This secondary trend was met with buying at the uptrend line from its 2002 lows as momentum diverged positively. Despite this initial weakness and several-month divergence from the other two indexes, utilities have recovered and appear to be continuing their primary trend higher. One final note here is that the Dow Jones Utility Average is not traditionally part of Dow Theory, but we still find value in monitoring it, as the three tend to move in tandem over the long term.
The last chart I want to highlight is an overlay of the Dow Jones Industrial Average and the Dow Jones Transportation Average over the past 20 years. In red, we've highlighted negative divergences between the indexes that led to significant secondary trends to the downside, and in green is a divergence that preceded the beginning of a new primary move to the upside. And if you look all the way to the right, you'll see that there's no divergence at the moment. In fact, both indexes are at five- and six-month highs.
The Bottom Line
While Dow Theory isn't necessarily a great tool to generate precise buy or sell signals, it is a good indicator to identify potential divergences that often precede a change in the broader market's primary trend. As of now, we're seeing confirmation from all three of these indexes resolving their year-to-date ranges to the upside. If the market was nearing a major turning point, we'd expect to see some sort of negative divergence in at least one of these indexes, but there aren't any as of yet.
When there's a lot of noise, it sometimes helps to take a step back and use simple exercises like the one above to get an objective view of the broader market's primary trend. For now, it looks like the market is headed for higher prices, but we'll continue to monitor these charts for any changes that might affect that thesis.
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