The fact that the Dow Transports are not confirming the rally in Dow Jones Industrials...is a warning of potential ugliness if you believe in Dow Theory.

Written by Sean Brodrick (UncommonWisdomDaily.com)

Take a look at the chart below:

(Updated chart)

You can see Industrials, shown as a purple line, are marching higher on the prospects of timid Fed rate hikes and big tax cuts but the Transports, tracked as a black line, are having none of it. They’re diving like a punch-drunk boxer. On the bottom of the chart, I’ve put a trend indictor. It shows the bearish trend in Transports is getting stronger.

Here’s how Dow Theory works, as I understand it.

1. To get a "buy" signal

  Both the Industrials and the Transports must undergo significant rally after hitting new lows. A "significant" rally is seen as 5%. But there is some argument over this.

  In a subsequent significant correction, one or both of these Dow averages must remain above those initial lows.

  Both averages must then rise above their highs registered at the top of the rally referred to in the first step.

2. A sell signal is triggered when both the industrial and transport indexes fall below the low of a previous retreat.

3. Finally, when either one of these indices makes intermediate highs and the other doesn’t follow suit, it’s considered a sign that markets will reverse and head lower. That’s what we’re seeing right now. The Transports are not confirming the big move higher in the industrials.

...Dow Theory was based on Charles Dow’s observations of the swings of the stock market. It was portioned out in a miserly fashion, in dribs and drabs through editorial in the Wall Street Journal. It was never codified into a clear and precise set of rules and that means there are arguments from time to time among Dow Theory’s most-ardent proponents but the non-confirmation in the above chart looks pretty clear.

Still, there are forces afoot today that Charles Dow never imagined:

•  airlines are a big part of the transports. They are reeling from
  • monster winter storms that caused expensive cancellations and delays and
  • President Trump’s travel ban is scaring away foreign visitors.
• many (not all) North American railroads are also under pressure and, with rare exceptions,
• trucking companies are suffering through a miserable March.

So if the real economy is slowing, maybe that’s a harbinger of a rough road ahead for stocks.

Is the economy slowing? GDPNow, a forecasting model used by the Federal Reserve Bank of Atlanta, thinks so. Take a look …

(Source)

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2017 was 0.9% on March 16...That’s pathetic!

Tax cuts will only get you so far. To support the kind of run-up we’ve seen in the Dow and S&P 500 so far, at some point, we’ll need growth in both the economy and earnings so the Transports may indeed have good reason to cry a warning - and investors may be wise to take it to heart. A tradable correction may be in the future.

Consider yourself warned.