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Will the Transports Lead the Industrials Up?

01/31/02 08:52:51 AM
by David Penn

As the Industrials successfully test a range bottom, the Transports move toward a test of an intermediate top.

Security:   DJI, DJT, DJU
Position:   N/A

Who to believe? The angel on your shoulder that speaks of good earnings and economic recovery? Or the devil on your other shoulder that points out bad earnings and economic weakness? The line in the Dow is making it difficult to read the market's opinion on the outlook for the U.S. economy. This line formed in mid-November just above 9600 and made a peak in early January just above 10200. Dow Theory posits that such lines tend to develop in primary bear markets following secondary corrections. The "purpose" of these lines tends to be distribution. With the Dow up 22% from the September 21st low, Dow Theory suggests that given the primary bear market, savvy traders are taking profits by selling to those who are arriving to the rally late.

As powerful as the secondary correction in the Dow has been, the rally did not take out the highs of the summer of 2001, in particular the June high of 10760. This makes the current "range rally" in the Dow worth watching, as the Dow has made successive higher highs in November, December and January, while holding at support at 9650. Should the Dow's pattern of higher highs continue, then taking out the January high of 10300 is the next objective.

A failed top test in utilities and a successful top test in transports could mean a top-testing rally in the industrials.
Graphic provided by: MetaStock.
One way of gauging the likelihood of a major Dow advance (and a new intermediate high above 10300 would be significant), according to Dow Theory, is to consult the Dow Transports. The Dow Transports made their successful range bottom test in mid-January, and are already headed toward a test of the intermediate top established in early January. Should the Transports set a new intermediate high and the old high become a source of support, then the possibility of the Dow similarly making a new intermediate high increases significantly. Conversely, if the Dow Transports fail to set a new intermediate high during the current rally, then it becomes less likely that the Dow Industrials will set the new high on their own.

Another helpful tool in analyzing the Dow Industrials is Dow Jones Utilities Average. Utilities, as a defensive sector, tend to trend inversely to the Dow Industrials. Additionally, the interest rate sensitivity of the utilities sector--caused both by the heavy borrowing costs of utilities companies as well as the dividend yields most utilities stocks pay shareholders, dividends which compete with money market accounts and bonds--makes them a valuable resource in studying the markets.

The DJUA presently looks to be rallying from a range top test failure. The Dow Utilities put in a bottom in mid-December and tested the mid-November high at the beginning of 2002. Resistance at 300 held, but the DJUA did not correct sharply, limiting its losses to 3%. While the retreat was too long to be considered a bullish flag, the mildness of the correction hints that a retest of the intermediate top by come sooner than a retest of the December bottom. This would be bearish for the Dow Industrials and, in concert with a failed top test in the Dow Transports, may provide a convincing enough signal before the Dow Industrials themselves begin to show obvious signs of weakness. Conversely, should the short-term rally in utilities fizzle out, and the correction from the DJUA's failed top test in January resume, and the Transports make a successful top test, there may be good reason to believe the Dow Industrials will also reach higher ground.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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