Dow Theory: The Emergence of a Divergence?

``Fools try to prove they are right. Wise men try to find when they are wrong.”-Dickson G. Watts

Finally, in my past edition, Excess Liquidity: Finding a Home in Assets Despite A Looming Slowdown (see Oct 23 to 27), I wrote of divergences which may presage for a much needed “healthy” correction,

``Even some argued further, that the Dow Transports which if based on the Dow Theory has so far failed to confirm the rise of its sibling index (Figure 5), aside from arguments that the Dow’s rise has been due to its structural composition being mainly price-weighted...Yes, the Dow and other key US benchmarks are likewise in strenuously overbought conditions and may retrench as they find an opportunity to do so, but my point is unless we see a genuine divergence, or moving in the opposite direction in contrast to the DJIA, by one or some or a combination of the other indices, to wit, the Nasdaq, the S & P 500, the NYSE, Russell indices or the Dow Transports, et. al., it would be impractical to dismiss outright the actions transpiring in the US equity markets as a nonevent.”

Figure 7: stockcharts.com: Dow Theory Divergence?

Then, I refused to join the ranks of the bears calling the rally seen in the US markets as “artificial”, given that it has inspired a worldwide phenomenon of rising equity market benchmarks.

Today, it appears that the 5-month inspirational run by the major benchmark, Dow Jones Industrial Averages, see figure 7, has been unaccompanied or is visibly undergoing some divergence as evidenced by a retrenching Dow Transports (upper pane).

Further, the Dow Transports seems to manifest of a bearish head-and-shoulders pattern (three arrows). Moreover, on the lower panel, the Dow Utilities index has likewise appeared to have rolled over.

The Transport’s Index failure to confirm its sibling’s (the Industrial Averages) test of its recent highs highlights the risks of a “top”. This will be further accentuated by a non-confirmation of the Utilities Index.

For the meantime, while it is too early to call for an inflection point, we will observe in the coming sessions for the continuity of the incipient deteriorations seen in both the Transports and Utilities Indices. Until such will be demonstrable enough to weaken the advances of its major benchmark counterpart the DJIA, we will simply tighten on our stops.