INVESTING: Lessons to draw from the new slide in transport stocks

One of the staples of a bear market is the futile attempt investors make to rationalize why they are staying invested. (This happens, of course, until it is far too late to do anything about remaining in the market).

After the June 14 market low, one of the common rationalizations I heard was that the Dow Jones Transportation Index was nearing an all-time high. But like visions of a dying man wandering in the desert, it turned out be another mirage.

The transports have been one of the strongest areas of the market since the March 2003 bottom. For most of 2006 until the May 10 market top, these stocks put on an impressive run. They were up more than 15 percent in only five months.

This is even more amazing considering that there was almost an airline bankruptcy a day during that span. As with the rest of the market, the transports suffered steep declines in May, but the rebound in June seemed to have everyone talking.

There are still quite a few people around who like to watch both the Dow Jones industrial average and the transports and use their price action as an economic indicator.

Charles Dow himself devised an indicator that today is called Dow theory. If the transports, but not the industrials, reach a new high, then that portends an economic slowdown. If both indexes slide to new multi-month lows, then a recession and bear market could be approaching.

Although I use more reliable methods of determining future stock market moves, the Dow theory is still valid. If factories are slowing and people aren’t shipping as much stuff, then a recession might be on the way.

With the transports cranking toward a new all-time high in June, investors were using that as a signal the bull market was alive and well. The index got within earshot of a new high, then stalled. But something changed in July and has been happening since. The transportation stocks have been getting smashed lately, even moving to a multi-month low in recent days. The fact that the stocks didn’t hit a new high seems extremely discouraging to investors. This selling is most likely the prelude to sharply lower prices. Investors would be well-advised to exercise great caution in the sector.

Lately, I have been giving the Dow theory a more intense look. I’ve been checking out an angle that has not gotten play in the media or from other analysts or managers.

The Dow Jones industrial average hit an all-time high of 11,750 in January of 2000. The index came within 1 percent of breaching that level this past May. Then just like the transports a month ago, the selling came in force. The fact that the Dow could not surpass that 6-1/2-year high after coming so close is an extremely ominous sign for investors. The implication is that the bear market most people thought ended more than three years ago is not yet complete. If that’s the case, then grab your crash helmets, folks. The ultimate bottom could be a long, long way down from here.