We Don’t Like Technical Analysis, But We Love This Chart

We Don’t Like Technical Analysis, But We Love This Chart

As an investment analyst, we’re always looking for signs.

Not road signs.

Not star signs.

And not signs from the tealeaves or other such hocus-pocus.

We’re looking for market signs — a sign from other investors, or from the market, to give us a clue about where the market is going next.

There’s one sign we’ve followed for some time. For a while, it looked bullish. But now it’s looking bearish again.

That should be a big worry for investors…

Your editor isn’t a chartist or technical analyst.

We openly admit that we don’t understand most of the lines or indicators that chartists stick on their charts.

We’re a fundamental analyst. We like looking at the big idea behind a company. We like to see how a company makes money…and how it (hopefully) makes a profit.

That’s how we make our investment decisions. That said, there is one chart that has caught our eye for the past two years. Details below…

What we don’t know about charting

As we say, we don’t know much about charting. We don’t know an Elliot Wave from a Mexican Wave. We don’t know a Fibonacci sequence from a DNA sequence. And we couldn’t tell you the difference between a Gann Fan and an electric fan.

But we do know one thing. We know logic when we see it. That’s why we’ve become so enamoured with the ‘Dow Theory’.

Now, the Dow Theory can be somewhat complex. And even its devotees have points of difference on how to interpret the charts.

But at its simplest, the Dow Theory says that in order to validate a bull market for the Dow Jones Industrial Average, you need to see a corresponding bull market in the Dow Jones Transportation Average.

When both are at a new high, that ‘confirms’ the bull market. Now, to be clear, just because one is at a high and the other isn’t, that doesn’t mean it’s not a real bull market. It just means the price action hasn’t confirmed it.

So, how has the Dow Theory played out in recent months? Check out the five-year chart below. The Dow Jones Industrial Average is the white line, and the Dow Jones Transportation Average is the orange line:


Source: Bloomberg
Click to enlarge

You can see that over the past month, both averages have soared to record highs. That should be confirmation of the bull market.

It’s especially interesting because the Transportation Average (white line) had failed to get anywhere near its high over the past year or so.

But now it has. Bull market, right? Not so fast. Check out the shorter-term chart. This covers the past month:


Source: Bloomberg
Click to enlarge

You can see that while the Industrial Average (orange line) has remained at or near its high point, the Transportation Average has slipped back.

Arguably, the Transportation Average is no longer ‘confirming’ the bull market. As we say, the Dow Theory is open to interpretation. Furthermore, it’s not realistic to expect two different indices to move step-for-step every single day.

Supported by logic

However, it still could be significant. The reason Dow theorists look at the relationship between these two indices is transportation stocks give you a clue about the movement of goods between and across an economy.

If industrial companies are making things, but it’s all being warehoused, that could suggest there isn’t a current demand for the goods from businesses and consumers.

In other words, you want to see that freight companies are actually shipping the products that industrial companies are making.

For that reason, it’s fair to ask whether the current rebound in stocks is genuine, or whether it’s just a hubristic response to the recent US election result.

While in one way it’s good that US interest rates are rising, there can also be little doubt that rising interest rates will harm heavily indebted businesses and consumers.

And that will affect the profitability of those (and other) businesses, and the ability of consumers to buy those products. It’s a double whammy. And that must surely be bad news for stocks.

That’s why we like the Dow Theory, and the charts that support it. It’s not based on squiggly lines, or so-called support and resistance lines, or other such questionable methods.

The Dow Theory uses logic. The kind of logic any fundamental analyst worth their salt should be able to understand.

Cheers,

Kris Sayce,
Publisher, Money Morning

Kris Sayce

Kris Sayce

Publisher and Investment Director at Port Phillip Publishing
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the editor of Tactical Wealth, and Microcap Trader — where he reveals the best opportunities he’s discovered in the markets. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays.
Kris Sayce is the Publisher and Investment Director of Australia’s biggest circulation daily financial email, Money Morning Australia.Kris is a fully accredited advisor in shares, options, warrants and foreign-exchange investments. Kris has close to twenty years’ experience in analysing stocks. He began his career in the biggest wasp’s nest in the financial world — the city of London — as a finance broker back in 1995.
It’s there where he got his ‘baptism of fire’ into the financial markets, specialising in small-cap stock analysis on London’s Alternative Investment Market. This covered everything from Kazakhstani gold miners to toy train companies.After moving to Australia, Kris spent several years at a leading Australian wealth-management company. However he began to realise the finance and brokerage industry was more interested in lining its own pockets with fat fees, commissions and perks —rather than genuinely helping out the private investors they were supposed to be ‘working’ for. So in 2005 Kris started writing for Port Phillip Publishing — a company which was more attuned to his investment outlook. Initially he began writing for the Daily Reckoning Australia— but eventually, took over Money Morning. It’s now read by over 55,000 subscribers each day. Kris will take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money! Whether you agree with him or not, you’ll find his common-sense, thought-provoking arguments well worth a read. To have his investment insights delivered straight to your inbox each day, take out a free subscription to Money Morning here. Kris is also the editor of Tactical Wealth and Microcap Trader where he reveals the best opportunities he’s discovered in the markets that you could profit from. If you’d like to learn about the latest opportunity Kris has uncovered, take a 30-day trial of Tactical Wealth here or Microcap Trader here. Official websites and financial e-letters Kris writes for:

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