Charles Dow is considered to be the grandfather of technical analysis; forecasting the direction of prices through the study of past market data, primarily price and volume. In his day, he theorized that the performance of the entire US stock market was governed by a select few industrial and railroad stocks. His belief led to the creation of two important indexes, the industrial and railroad (now the transportation) indexes. The industrial index is still in existence today despite its evolution to remain relevant to the modern economy. The great companies held in each one of these indexes are thought of as the bellwethers of the modern-day stock marketplace. US stocks, often represented by these particular indexes, are at all-time highs and have been consistently strong. Many investors question how long this will last.
A combination of production and price increases provides a window into demand trends for the global economy. Almost every industrial and transportation company has now issued their latest quarterly reports. Many of the companies in the industrial index, and almost all of the companies in the transportation index reported higher revenue generation. A dissection of industry reveals that consumer credit and oil and gas companies were important revenue growth contributors. The highest revenue generating companies were in the basic materials and energy sectors. Consumer defensive stocks, such as food and beverage companies weighed down the average growth rate of revenue with virtually non-existent revenue gains.
Although revenue growth is generally attractive, demand for owning stocks has certainly outpaced the demand for the products and services provided by the companies. Also, price gains by the stocks in the industrial index have more than doubled the price gains made by the stocks in the transportation index. However, in the latest quarter, the growth rate of revenue among transportation stocks as a whole was exceedingly better than the rate of revenue growth among industrial stocks as a whole. This is an example of how investors often respond to information unpredictably. In addition, this illustrates how certain sectors, such as transportation stocks may offer more resilience in the case of a market downturn.
“US stocks are at all time highs and have been consistently strong. Many investors question how long this will last."
From a technical analysis perspective, the industrial index has made higher highs on advances and higher lows on declines since the beginning of the year. In addition, the 50-day moving average of the industrial index has acted as a support line when constituent stocks were sold. The upward price trend seen in the 50-day and 200-day moving averages of the industrial index is extremely supportive of favorable stock market sentiment.
Conversely, the price trend of the transportation index has not kept pace with the price trend of the industrial index. The aggregate price of the transportation index has breached the 50-day moving average multiple times and the 200-day moving average once. In addition, the transportation index has made multiple new lows this year. Setting new annual lows is a bearish pattern, which is why the performance of the transportation and industrial indexes have diverged so much this year. This divergence illustrates how all stocks should not be viewed collectively when making assumptions about market heights.
Although technical analysis can provide insight into market heights, it is not foolproof. The industrial index’s strength made it impossible for chartists to forecast a trend reversal of this already long bull market. And, as of recently, the transportation index has soared back and made a new high, which undoubtedly inflicted a lot of pain to all of the transportation bears out there. Bull markets can, and often do, persist longer than expected.
For all of the Charles Dow acolytes out there, the stock market performance of the industrial and transportation indexes is suggestive for the broader stock market to remain intact. Further, recent revenue growth data is also generally a positive sign. Accordingly, until enough evidence is accumulated to favor a trend reversal, Dow theorists can still proudly proclaim that this ‘trend is your friend’.
There was plenty of financial data and news headlines to digest in October. Many publicly traded companies released their earnings reports; the House Republicans put out a tax plan; Jerome Powell became a serious contender as a next central bank leader; more jobs were added in October even though the labor force participation rate fell; annualized US domestic output grew at a 3% rate last quarter; and European growth and inflation slightly crept down. Much of this data was good enough to push global equity markets higher. Foreign stocks and bonds, as well as certain alternative asset classes continue to provide sizable benefits relative to traditional US stocks and bonds. This has yielded attractive results for our Core Allocation portfolios. To date, these portfolios continue to outperform the Morningstar World Allocation and Tactical Allocation funds.