The predicting power of transportation sector

INDEX:DTY0   DJ Transports
411 14 4
Important points to consider:

- Transportation sector has been widely used as leading economic activity indicator
- The correlation of Dow Jones with Dow Transportation index is high
- The divergence between both usually result in sharp rally followed by correction with same magnitude
- After last week sharp drop of the Dow Transportation index there is high probability that we are witnessing the same pattern
I would suggest that you also overlay the price of "energy" on this chart. You can use the OIL etf and it might give you some new thoughts to ponder. I've seen far too many analysts over the past 25 years incorrectly predict the future based on divergences in these two averages. The way to interpret this pair might be to just put on pairs trades such that you are not predicting one market directionally based on a non-leading indicator. The transports could just as easily lift up to catch up to the industrials. Shorting the industrials makes sense with a long position in the transports.
Appreciate your advice, however the chart's main goal is to spot unusual movement (divergence) for the strongly correlated indices and to identify following DJIA direction, not to assess relative performance of the sectors.

The question is: why did transportation stocks fell when market did not?
The answer: unloading transport stocks when industrials grow is the first signal for upcoming problems. DJT divergence is an early indication that probably we are some 2 to 4 months away from peak (if we use previous two divergences as benchmarks).

Speaking of OIL etf and its reverse performance with the industrials you are correct.

As chart shows after divergence period transports usually catch up to the industrials.
timwest PRO CapitalHubs
Thanks for your reply. I appreciate the many different opinions that are expressed here. I'm also I'm fully aware of the theory behind watching the Industrials versus the Transports. There is just not a great track record of predicting with the method. I have the experience of listening to and reading Richard Russell for decades. He rarely got it right (I'd say less than a .200 batting average). I find I shy away from making all the bold forecasts and instead just put targets and stops. If there is no stop on a recommendation, then it is not fully thought out. So, how much are you willing to risk to catch a decline in the DJIA?

As for the Transports doing poorly, the reason why will be clear someday but here's a few guesses:
1. The drought was causing a major disruption of shipping traffic on the Mississippi.
2. The sharp slowdown in China was causing changes in the production of steel here in the US.
3. The low price of natural gas was causing a sharp drop in the amount of coal being moved on rail.
4. Turmoil in European debt financing made investors nervous and they chose to sell transportation stocks first. With the DJIA having more consumer staples and financial names, it has held up better.

Thanks for pointing out the divergence and how about taking a look at gold versus oil and see if there is an indicator there. Gold versus gold stocks is also historically wide.

There is an article at seekingalpha this weekend that outlines that the Dow does best after a period when there is a divergence in the Transports. See what you think.
Find it consistent with my findings. Recall: "The divergence between both usually result in sharp rally followed by correction with same magnitude". This is not my opinion but what happened previous two times.
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