By Mark Hulbert at Marketwatch
The Dow Jones Transportation Average is seriously lagging behind the broader stock market, and that’s potentially quite bearish.
Few people are focusing on this divergence, however, and fewer are even aware of it, especially as the stock market keeps hitting new highs. Another record occurred as recently as Thursday, though even then, the divergence was very much in evidence: Though the Dow Jones Industrial Average DJIA, -0.04% and the S&P 500 SPX, -0.02% each rose by more than 1%, while the Dow TransportsDJT, +0.68% did less than half as well.
The divergence began late last November, when the Dow Transports rose to a record high. They are now 6.7% below their all-time closing high (and 7.6% below the intra-day high). Over the same period, the Dow Industrials have risen more than 2%.
You’d think that wide a divergence would grab investors’ attention, but you’d be wrong. Sentiment surveys, including those from the Hulbert Financial Digest, are showing high levels of bullishness.
How bearish is this divergence? To come up with an answer, Jack Schannep recently focused on periods over the past 25 years that included big divergences. Schannep is the editor of a market-timing advisory service called TheDowTheory.com.
Schannep found 14 such instances. In nine of them, he says, the broad market subsequently dropped by less than 10%. But in the remaining five cases, the stock market’s eventual decline averaged 25.7%.
Those are sobering odds. If we average all 14 instances of prior divergences similar to the current one, the market eventually fell more than the 10% threshold for a correction. If that turns out to be the case this time around, it would be the first correction since 2011.
Even more ominous is that in five of the 14 cases, or more than a third of the total, the divergences presaged a full-scale bear market. In fact, Schannep points out that when the broad market hit its bull-market highs in 1990, 1998, 2000 and 2007, the Dow Transports in each case had already turned down several months before.
Schannep hastens to add that “the market doesn’t always drop significantly after a divergence.” But if the future is like the past 25 years, we should be prepared for at least an imminent correction, if not something even worse.
Despite sharing those concerns, Schannep officially remains on a “buy” signal. But if we use the metaphor of a green light for being outright bullish and a red light for being outright bearish, Schannep says a yellow light — for caution — is an appropriate characterization of his current posture.