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Underneath Dow Theory and the Lagging Transportation Index

The difference between the Dow and DJTA 52-week returns reached 20% in early July

Senior Quantitative Analyst
Jul 31, 2024 at 8:00 AM
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While the Dow Jones Industrial Average (DJIA) hit an all-time high this month, the Dow Jones Transportation Average (DJTA) has remained stagnant for several months. The chart below shows the Dow and the DJTA percent return over the past 52 weeks. During this period, the Dow has gained about 15%, whereas the DJTA has been below breakeven the whole time.

Charles Dow famously asserted an uptrend in the Dow should be confirmed by the DJTA. Intuitively, it makes sense that if the economy is doing well then, the companies moving products around the world should also be doing well. This week I’ll look at historical instances when the Dow performed considerably better than the DJTA to see if that is in fact a bad omen for the stock market going forward.

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Year-Over-Year Divergence

Earlier this month, the difference in the 52-week returns of the Dow and DJTA reached 20%. It’s the first time that’s happened in over 25 years. Going back to 1950, it’s the ninth time we’ve seen the gap reach 20%. The table below summarizes the Dow returns after previous gaps. Based on Dow Theory, you might expect some underperformance in the industrials index but that’s not what we’ve seen after prior signals. In the month following these occurrences, the Dow averages a return of about 2.5% compared to the typical one-month return of 0.69% since 1950. Over the next 12 months, the Dow has averaged a return of 16% with eight of nine returns positive after these signals. The typical 12-month return has been about 8.4%.

iotw2jul30

Using the same signal dates as above, here is how the transportation index (DJTA) has performed going forward. The index also outperforms going forward as measured by the average return over the next month and 12 months. The outperformance is not as stark, however, for the DJTA and less than half of the returns were positive over the next month and three months.

iotw3jul30

Next, I show the individual Dow returns after each of the signals. The bolded rows show the cases where the Dow was up double-digits year over year and the DJTA was negative. That’s the situation we saw recently. The 12-month returns after these instances that most resemble our current situation have been underwhelming. The Dow lost 7% in one case and gained less than 2.5% in the other two cases.

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Finally, here are the DJTA returns after the individual signals. The returns after the signals most like the recent signal (the bolded rows) show a 3.4% gain then two double-digit losses over the next 12 months.

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