Dow Jones Transportation Index Signals Trouble Ahead

Dow Jones Transportation IndexIt is summertime, and you expect the trading action in the stock market to be subdued, but there’s a big divergence taking place, and it isn’t good. The Dow Jones Transportation Index is not confirming the primary trend of the Dow Jones Industrials or the S&P 500 Index. The divergence started in mid-July and follows a stock market with lackluster trading volume and poor breadth.

The Dow Jones Transportation Index reflects current fundamentals, more so than the other stock market averages, which have been going up on the hope for new action from the Federal Reserve. This is why I think the stock market is in the process of topping out. Unless we get a big boost inU.S. economic news or new monetary stimulus from the Fed, I don’t see how the stock market can advance further.

Since the beginning of June, the Dow Jones Industrials, the NASDAQ Composite, and the S&P 500 Index have all done well, albeit on low trading volume. But the divergence with the Dow Jones Transportation Index really bothers me, because many of the large-cap companies that make up the Dow Jones Transportation Index have been excellent stock market leaders for some time now. (See “The Top Stocks Making Money in This Market Right Now.”) If the divergence continues, this will be a bad technical signal.

With the Dow Jones Industrials over 13,000 and the S&P 500 Index at 1,400, I’d have to say that the stock market is fairly but fully valued. Corporate earnings have been exceptionally good, considering all the turmoil in the global economy, and it is difficult to see how corporate profits can accelerate in an environment where revenue growth is declining. Regardless, stock market investors have been bidding, and without some new policy action from the Federal Reserve, we’ll likely get a major correction.

Large-cap stocks have been the driving force of the stock market since 2009. Dividend paying stocks that make up the Dow Jones Industrials and the S&P 500 Index have been and will continue to be the market leaders in a slow growth environment. Even a three percent dividend yield from a large-cap company is arguably a better investment than cash. Whether you owned the S&P 500 Index or the Dow Jones Industrials, without those dividends, you would still be losing money from the stock market in recent history.

Oil prices recovered from their recent correction, but under $100.00 a barrel, oil prices are not onerous. And this is what’s troubling about the Dow Jones Transportation Index. I don’t think oil prices are the reason for its weakening performance. I think it’s a signal that the stock market is getting very stretched at this time and that a market top isn’t far away. You can’t fight the Fed, that’s for sure, but between now and the beginning of 2013, I see a major correction.