Dow Theory Devotees Beware: Rare Transports Signal Sounded

The Dow Jones Transportation Average (DJT) has underperformed the Dow Jones Industrial Average (DJIA) recently

Mar 15, 2017 at 1:26 PM
facebook X logo linkedin

March has been rough for the Dow Jones Transportation Average (DJT), with the index down more than 2.4% and trading beneath its 50-day moving average for the first time since September. What's more, the DJT has been severely lagging the Dow Jones Industrial Average (DJIA), which could have Dow Theory devotees on high alert, sending up a historically bearish signal. Below, we'll explore how blue chips and transports tend to fare after Dow/DJT divergence, and dig into a couple of DJT stocks dragging on the index (and garnering interesting activity among options traders) -- American Airlines Group Inc (NASDAQ:AAL) and Delta Air Lines, Inc. (NYSE:DAL).

Dow Transports Underperformance Sounds a Bearish Signal

The DJT has shed 0.3% in the past three months, while the DJIA has added a whopping 5.5%. Historically, this kind of underperformance from transport stocks has been bearish for both the DJIA and DJT, according to data from Schaeffer's Senior Quantitative Analyst Rocky White.

DJT underperformance signals since 2000

In order to constitute a "signal," the three-month relative strength of the DJT to the DJIA had to be 0.92 or less, and the DJIA had to be positive (so a signal isn't generated when the DJIA falls 8% and the DJT falls 20%, for instance). Until now, we haven't seen a signal since December 2015. Prior to that, you'd have to go back to September 2012. There have been only eight of these signals since 2000.

Going back to 1950, there have been 40 signals in all, and the DJIA has fared poorly afterwards, averaging losses at the two-week, one-month, and three-month marks. Further, the DJIA was positive less than half the time at each of these markers. For comparison, the Dow is typically positive at these markers, looking at anytime returns since 1950. The biggest discrepancy comes three months after a signal, with the DJIA averaging a loss of 0.2%, compared to an anytime three-month return of nearly 2%. Standard deviation is higher for the DJIA after a signal, too, pointing to elevated volatility.

Dow Jones Industrial Average after Transports signal

It's even more pronounced for the DJT. Transports also tend to underperform, with the DJT lower at each short-term marker after a signal. Looking three months out, the DJT has averaged a loss of nearly 0.8% after a signal, and was higher just 47.5% of the time. Since 1950, the DJT averages a three-month anytime gain of 2.5%, and was higher 61.3% of the time.

Dow Transports after Dow underperformance signal

Airline Options Active as Sector Drags on DJT

As alluded to earlier, airlines -- a big part of the DJT -- have been struggling amid winter storm cancellations and ahead of President Donald Trump's travel ban 2.0, set to take effect after midnight tonight. AAL has dropped more than 10% so far in March, and yesterday marked its lowest close since before the November election. Likewise, DAL stock has surrendered nearly 6% month-to-date, and Chief Financial Officer Paul Jacobson today warned that revenue is "not picking up fast enough to cover" escalating fuel costs.

As such, options volume on AAL and DAL has taken off, so to speak. On Monday, AAL options volume hit its highest point since early August, with roughly 70,000 calls and 28,000 puts exchanged. Meanwhile, DAL options volume touched a more than 12-month peak, with a whopping 115,000 calls and just 12,000 puts traded.

Delta Air Lines DAL stock options volume
Chart courtesy of Trade-Alert

Speculators added May 45 calls on AAL, which saw the biggest overnight open interest increase, with nearly 12,500 contracts added. The contracts were apparently bought to open, amid expectations for AAL to retake $45 within the next couple of months. AAL shares were last seen 1.7% higher at $41.91. The DAL June 50 and 55 calls garnered the most attention yesterday, in what appears to have been a massive bull call spread established for $0.94 apiece, or $1.88 million ($0.94 x 100 shares per contract x 20,000 spreads). The spread will profit if DAL topples $50.94 (bought strike plus premium paid) by June expiration. DAL was last seen 1.7% higher at $47.08.

However, if history is any indicator, the underperformance of the Dow Jones Transportation Average (DJT) to the Dow Jones Industrial Average (DJIA) is a bearish tell. So if past is prologue, those AAL and DAL options bulls may want to take cover, with more short-term turbulence for transport stocks on the horizon.

Don't miss Schaeffer's free weekly stock market forecast. Sign up now for Monday Morning Outlook.

Unlock Weekend Profits with Chris Prybal's Favorite Strategy Up +487.5% in 2024

With the markets going left, right, and sideways, you need to have a plan now more than ever. 

Expert Trader Chris Prybal is no stranger to volatility, and has mastered finding big stock rallies while other traders aren't looking over the weekend. Rallies that produced gains like +207% on RTX calls, +236% on MARA calls, and +238% on NET calls.

A few simple moves on Sunday at 7pm could be the “Secret Sauce” your portfolio needs to not just stay afloat, but make unprecedented gains in this turbulent market.

Don’t sit on the sidelines, beat the market with Chris Prybal's strategy. Join him now!