Posted by Adam Turnquist, CMT, VP Chief Technical Strategist
Friday, July 21, 2023
Key Takeaways:
- Expanding market breadth and renewed hope for an economic soft landing have recently pushed the Dow Jones Industrial Average (INDU) and Dow Jones Transportation Average (TRAN) to new 52-week highs.
- The breakout on both indices checks the box for one of the key tenets of Dow Theory—the averages must confirm each other.
- The buy signal also adds to the evidence that the primary trend of the broader market is higher. In addition, Dow Theory buy signals based on the INDU and TRAN confirming each other’s breakouts have historically produced above-average gains for each index.
Win Streaks & Confirmation
After spending most of the year in a consolidation range, the INDU has finally started to play catch up to the broader market. The recent expansion of this year’s rally beyond the mega-cap space has lifted the index above resistance from the November high at 34,590. The breakout was powered by above-average volume this week and confirming momentum, including a well-timed buy signal from the Moving Average Convergence/Divergence (MACD) indicator.
Buying pressure has also been steady as the blue-chip index is currently on a nine-day winning streak, its longest since 2017. Since 1950, the INDU has only strung together nine consecutive days of gains 25 times. Of these occurrences, 52% extended the streak to 10 days, with the longest period extending to 13 trading days. The chart below highlights INDU returns after a nine-day winning streak was recorded.
Following a nine-day winning streak on the INDU, forward returns have historically been above-average, with relatively high positivity rates. For example, 12-month returns after a nine-day winning streak have averaged 10.4%, compared to the INDU’s average 8.5% rolling 12-month return for all timeframes dating back to 1950. In addition, we found that most winning streaks of this magnitude occurred during strong bull markets, as annual returns for years that included a nine-day winning streak averaged 17%.
Broadening participation and renewed hope for an economic soft landing have also helped the TRAN rally nearly 20% since June. The index is now trading at a 52-week high after clearing resistance off the February high at 15,641.
Both price-weighted indexes are primary components of Dow Theory—a technical framework dating back to the early 1900s that is generally used to define market trends. Charles Dow, co-founder and editor of the Wall Street Journal, is credited for the original theory. Dow classified the market into three trends, which he compared to the tide (primary trend), waves (secondary trend), and ripples (minor trend) of the sea.
As Dow wrote in the Wall Street Journal in 1901, “A person watching the tide coming in and who wishes to know the exact spot which marks the high tide, sets a stick in the sand at the points reached by the incoming waves until the stick reaches a position where the waves do not come up to it, and finally recede enough to show that the tide has turned. This method holds good in watching and determining the flood tide of the stock market.”
One of the tenets of Dow Theory is that the averages must confirm each other, meaning breakouts and breakdowns should happen in concert. Conceptually, Dow observed in the late 1800s that raw materials would need to be transported via railroads before economic expansion could begin. Subsequently, robust rail activity would typically portend favorable economic conditions for industrial companies.
Given the recent breakouts on both indexes, a Dow Theory buy signal has now been triggered, adding to the evidence that the primary trend for the broader market is higher. Furthermore, we backtested buy signals based on overlapping breakouts to new 52-week highs for the INDU and TRAN indexes. We applied a minimum drawdown of at least 10% to precede each buy signal and filtered for signals occurring at least three-months apart. The table below shows the INDU, TRAN, and S&P 500 (SPX) average forward returns after a buy signal was registered.
Dow Theory buy signals based on the INDU and TRAN confirming each other’s breakouts have historically produced above-average forward returns. The TRAN index tends to outperform both the INDU and SPX following a buy signal, including an impressive forward 12-month return of 17.5%.
SUMMARY
Broadening participation and renewed hope for an economic soft landing have pushed the TRAN index to a new 52-week high. The INDU has followed suit and broke out to a new 52-week high this week amid a nine-day winning streak. Given the recent breakouts on both indexes, a Dow Theory buy signal has been triggered, adding to the evidence that the primary trend for the broader market is higher. Dow Theory buy signals based on the INDU and TRAN confirming each other’s breakouts have also historically produced above-average forward gains for each index.
IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.
Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value