The ‘Eyes’ Have It

OVERVIEW:  It’s the “ayes” and “nays” that count in an election, but since we don’t have those results yet we’ll focus on what we can see with our own eyes. The last Letter showed the Dow Jones Transportation Index moving upward, belatedly, toward their old highs, a successful breach necessary to flash an “in the clear” signal for the Dow Theory and the stock market as a whole. As you can see from the following graph that pattern still prevails without success yet, so why is it important? The Transports are, after all, only one industry of many in our broad U.S. economy, yet they are the one used as confirmation of the Dow Jones Industrials in the Dow Theory because they “deliver the goods” that the Industrials produce. They also were the only other Index available (previously named the Railroad Index) to Charles Dow 100 years ago when he first developed what became known as “Dow’s Theory”. Actually today the Index is made up of five related industries: airlines, air freight, railroads, transports miscellaneous and trucking, so it is a broader index than most give it credit for. With that brief background, let’s now see what they’ve done for us lately.

     Most recently you’ll remember that they “Saved Our Bacon” in May, 2004 by not going down along with the Industrials which prevented an incorrect Sell signal from occurring around the 9900 level (before rising to 12,100+ this year). They also diverged in 1999 by not going up to new highs with the Industrials and prevented an incorrect Buy signal from occurring around the 11,500 level (before dropping to 8233 in 2001). The difference between then and now is that we were under a Dow Theory Sell signal then and now we are under a Buy signal, looking either for further confirmation or the divergence to lead to a change. Previously, that was also the situation when the Transports failed to follow the Industrials and S&P500 to new highs in July of 1998 and July of 1990 when Sell signals followed and the stock market dropped 19% and 21% respectively. So what the Transports do now really is important!  Keep an eye on this index.

THE DOW THEORY:  Current Signal: Still in a Buy mode (GREEN), 100% invested since May 2nd, 2003 at the 8,582.68 level. The Dow Transport’s divergence continues but they DO appear to be catching up. At the time of the last Letter it needed to rise just under 8% but now the further gain needed is just under 6% from here to reach new highs and “confirm” the direction of the Industrials and the S&P500. If it fails there could be trouble ahead.

SCHANNEP ­TIMING ¯INDICATOR:  Current Signal: Re-Buy (GREEN) as of 10/12/06 at 11,947.70. As I pointed out in the last Letter, there is a similarity with the Re-buy in December of 1999 at 11,286.18 during the markets “last hurrah” on its way to 11,722.98 in January, 2000. That was not meant to imply a repeat of that erroneous signal, only that we need to continue to monitor this and the Dow Theory for change as the outlook for the market is still in the grip of “soft landing or recession”. The votes are still not in on that outcome. Obviously there will be another recession; it is only the timing that is in question.  I first showed the relationship of housing starts leading the economy into, and out of, recession back in 1989 before the 1990-91 recession. In the April Letter I wrote that “A contributor to a recession will likely be the unemployment increase due to layoffs in the home-building industry”. The current situation should have all eyes zeroed in on the possibility of housing starts once again pointing to recession:

The COMPOSITE Timing Indicator:  Current Signal: Full Buy mode (GREEN) from the purchases in 2003/04 at an average entry level of 9,536.05 and last month at 11,947.70 for a new average entry level of 10,741.19. This fully invested position will remain in effect until one or the other or both of the above Indicators change from their Buy mode.

ÞThe BOTTOM LINE:  The bull market continues to “chug along” in the face of the double threats of terrorism and recession, that’s commonly called “climbing a wall of worry”.  If there were nothing to worry about the market would be at 16,000 or thereabouts, and one day it will be, but in the meantime expect a bear market and recession to occur first. A 25% rise from here just does not seem to be in the cards given the extended economic recovery and extended bull market we have already had. Our “Three Tops and a Tumble” are still in play with the Yield Curve inverted most of this year, Consumer Confidence and NYSE Volume both having topped, so far at least, several months ago.   Yes, the market can continue its climb as those who doubt history keep the “pot boiling”. By the way, Happy Halloween!!

Jack Schannep
Dow Jones:      12,080.73
S&P 500:           1,377.94
NYSE:               8,782.57

real-time, real money (Roth I.R.A.) conservative portfolio for serious major-trend investors is both the recommended ‘core’ portfolio of this Letter and also a bench-mark for your own investment results. Aggressive investors might use other more speculative investment vehicles in an attempt to improve on these results but I have chosen Exchange traded ‘Index’ funds and ‘Cash’ funds as the best ‘pure play’ vrs. Buy & Hold.

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