White Knuckles

Industrials and Transports go their separate ways

Industrials and Transports go their separate ways

 

Dow Jones Industrial Average

close 18,000.40 +236.36 / +1.33%
Today’s Volume 96,983,297
3 month Average Volume 98,752,666
Average P/E 17.3
1 year Change +6.22%

Dow Jones Transportation Average

close 8,363.47 +56.13 / 0.68%
Today’s Volume 15,389,073
3 Month Average Volume 15,622,298
Average P/E 19.7
1 Year Change +1.94%

Inevitable Divide

At all times, in healthy markets of course, one can assume that as goes the transportation of goods, so goes the manufacturing of them.  When I worked in lending over a decade ago, I was smack in the middle of the greatest real estate boom in my lifetime, perhaps in most everyone’s.  I learned an important lesson at that time, a home is only worth what someone is willing to hand you a check for.  Replace the word “home” with, well, literally anything, and it’s a good reminder that what you think perhaps doesn’t reflect reality.

In a perfect world, a company’s share price would actually equal its value, or at least its assumed value over a period of time, hence the devotion to P/E for many investors.  However we live in… well, lets NOT call it an imperfect world, as that’s obnoxiously obvious, but instead call it a hyper-realistic world, as the markets are inundated with speculation, leverage, and at times an unfortunate amount of hope and expectation.  But I digress.

The point being, if you manufacture a good, that good is only worth what someone is willing to pay for it.  Few companies have the luxury of Apple at setting whatever price they choose for the next-gen product they produce.  Most companies do not have the privilege of selling to the modern tech-addicted masses.  Most are subject to the buyer, and finding a happy medium between supply meeting demand, and the profits which can be earned in the middle.  So in this supposed “perfect” world, once demand has been met, and a price agreed upon, the manufacturer has to get their stuff to the consumer.  Here in lies the all-importation relationship between the Industrial Average and the Transportation Average.  It’s irrelevant how many goods a company produces.  If they don’t go to market and aren’t bought, the company reaches an unavoidable end.

Between May and December, 2007 the Dow Industrials began their final leg up in a clear head and shoulders pattern with quasimodo geometry (see chart below).  Hindsight being what it is, patterns are quite easy to see after the fact, but during those months, it would have appeared the Industrials were simply making a sideways consolidation, possibly into it’s next leg up.  The Dow Transports did not confirm in a similar fashion, giving hint towards the 53% drop over the subsequent 6 months.  We see the makings of the same price activity over the last few months.

djia 07 - 08 wreck

Patterns are simply indications of possibility, but given my personal rules for both trading and investing, this movement in 2007 was a shorting opportunity in the Dow Industrials.  The confirmation which the Dow Transports had previously offered, by trailing downward as the Industrials consolidated and continued to move upwards to create Quasimodo’s head, gave additional support to the theory that the markets may be taking a break for a while. Of course why that break was a 50% loss instead of a simple and healthy 10% or 20% sell-off is a different story for a different day; lets just say that the power of leverage met with margin calls, and the uneducated investor panic that ensues can be, well, we all lived through it so we all know.

Story Time : When I was a kid my family moved from the mountains of Colorado to the hills of North Carolina.  It was a long trip, and it was made a few times and I’ve grown rather familiar with Interstate 40.  Once we hit Albuquerque, NM, we would be on the same road until just before we reached our new front door, 1,500 miles of I-40.  I learned later in life as I started making some of my own trips around the country that there are two types of driving.  Most of that trip, and others like it involve a pretty relaxed posture, cruise control, loud music, windows down, daydreaming while soaking in the scenery and smoke ’em if ya got ’em.  But then on day two, you hit Oklahoma City (or any other major area you aren’t familiar with) at 5:30 rush hour and the mood changes.  “Sit up and make sure your seatbelt is on,” Dad says from the front seat.  Music turned down some, windows rolled up, you’re now in an unfamiliar and overcrowded sea of people.

(On a side note, it is an interesting and apparently universal reality that everyone turns the radio down when it’s time to concentrate.  I suppose we only have so much of our “senses” to be passed around, and some of that firepower needs diverted from the ears and towards the eyes.  My personal favorite is when someone says, “what’s that smell” and turns the radio down to take a big whiff, determining whether or not the smell of burning oil or rubber is emanating from the car they’re driving.  Somehow quiet makes your nose work better?)

I’m not calling for the next crash, no one wants that, but any sideways consolidation in any market is like rush hour in a major city.  It is a sea of people deciding what to do next; shall we continue on our merry way, or is there someone out there veering into the wrong lane at the wrong time?  Corrections are mandatory in any market, and the unwinding of leveraged positions can be a detoxifying shock to the system, far beyond what is necessary just to shake out bad investments.  Investment corrections are like the initial car wreck on the highway, they happen, we wish they didn’t but they are inevitable, we see them often.  Corrections don’t cause crisis, but the guy following a few car lengths behind who is so focused on watching someone ahead of him crash that he doesn’t realize he is about to as well.  It seems it’s the 2nd guy that often causes the pileup.  I saw this happen outside of Chicago once, EMT was pulling someone out of a car ahead of me on the side of the road.  It was late and dark and that wreck involved 1 car and had clearly happened at least 20 or 30 minutes prior.  All of a sudden the car which had been driving 50 feet in front of me for the last 20 minutes starts swerving until they managed to get turned 90 degrees and slams into the concrete bunker on the side of the highway (thankfully none of the police or paramedics were hit).  It’s amazing what the body can do when the mind stops paying attention, the way the car moved, you would have thought he did it on purpose.

Healthy investment consolidations can lead to margin calls, and finally to panic.  We’ve had some great highway driving for the last 5 years, with a few small towns, a little occasional traffic and stop lights along the way, but ultimately the radio’s been turned up, the windows down, elbow out, your shoes are off driving barefoot with the cruise control on.  I’m not telling you to pull your financial car over to the side of the road and start crying, but I am encouraging people, myself included, that we’re coming into a city and there’s a lot of people out there decided which way they’re going to go.  We’re in a consolidation with a hint at a dropping Transportation average… it’s probably nothing, but a little experience tells me it’s time to divert attention from the day dreaming.

The only guarantees I can make is that at some point in the future we will have a sell-off in equities, which brings huge opportunities for those prepared to switch positions when necessary and increase their portfolio positions at better pricing.  Like my father in OKC 20 years ago, I will be paying attention over the next few months, white knuckled at alert, until BOTH the index averages set new highs.

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