Trying to Find Message in Out-of-Sync Indexes
The stock market is looking terribly confused, and when that happens, it often spells trouble ahead--or opportunity, depending on your frame of mind.
The confusion is best illustrated by the divergent patterns of the three Dow Jones indexes: the 30 industrial stocks, 20 transportation stocks and 15 utility stocks.
* The industrial index has been waffling for the past three weeks, unable to keep its momentum after setting an all-time high of 3,004.46 on April 17. Investors in the industrial stocks suddenly seem unsure that the economy will climb out of recession any time soon. At Friday’s close of 2,912.38, the Dow is 3.1% below its April peak.
* The transportation index has been in a persistent strong up-trend as investors flock to railroad and airline stocks. A healthy appetite for those stocks usually indicates that investors are confident about an economic recovery--which is quite the opposite of what many industrial-stock investors are feeling. The transport index, at 1,166.08 on Friday, is just 1% below its April peak of 1,178.07.
* The utility index has been the worst of the three. It has sunk like a stone since mid-April as investors have turned bearish on interest rates, believing that rates won’t drop any more and may instead rise. The utilities, viewed as fixed-income investments because of their high dividend yields, often are a leading indicator of an overall market top. The utility index peaked on April 16 at 220.98 and has since fallen 5.1% to 209.82 as of Friday.
Ideally, technical analysts--people who follow past market patterns on charts for a clue to how stocks might move in the future--like to see all three Dow indexes moving together. That indicates a strong and broad market trend.
In late January, for example, the indexes were all in sync, which was a powerful signal that the market rally had staying power.
At the very least, technical analysts want the industrial and transportation indexes to “confirm” each other’s moves. The so-called Dow Theory says that when the industrial and transport indexes reach new highs or new lows about the same time, they are trumpeting a major trend in the market.
So what does it mean that the indexes are out of sync now? Three weeks isn’t all that long a period to form a view of the market trend, admittedly. But Richard Russell, who publishes the Dow Theory Letter from La Jolla, believes that the transportation stocks have become dangerously overvalued in their latest surge.
With the industrial stocks disbelieving the transports’ move up, the market’s previously broad advance “is at the point of breaking down,” he says.
Russell, who has long been bearish, also notes that the all-time high for the transportation index was set Aug. 30, 1989, at 1,547.30. So the index now is 25% below that peak, while the industrial index set its all-time high just 12 days ago.
Rather than viewing the transports’ current strength as a positive catch-up phase, Russell says the long-term divergence between the transports and industrials is even more worrisome than the short-term divergence.
“I’ve never seen them so out of sync,” he says. To Russell, it’s a sign that the market as a whole is in a “massive top formation,” most likely leading to a severe decline.
Many other analysts, however, say the Dow Theory isn’t what it’s cracked up to be. And besides, they point out, you can wait so long for the transports and industrials to get their collective act together that you end up missing a major move in most stocks--like the rally that began in mid-January.
In August, 1989, the transport index rocketed because UAL Corp., the parent of United Airlines, was in the midst of a leveraged buyout, which later collapsed. So the buyout action was “noise” that caused the index to spike; it had nothing to do with fundamentals.
In recent weeks, the transport index’s strength has mostly been fueled by rail stocks. They were helped when a potentially crippling national strike was averted.
More important, technical analyst William Raftery at Smith Barney, Harris Upham in New York believes that the investors buying rail and airline stocks in anticipation of a recovery soon in those businesses are correct--even if that doesn’t mean all industrial stocks will recover at the same time. “The rails are looking very much like they’re in a major bull market,” Raftery says.
What about the sinking utility index? Doesn’t that suggest interest rates are heading higher, potentially derailing all stocks?
Raftery says no. The utility index is made up of electric utility stocks and gas utility stocks, and the gas stocks have been the weaklings lately, he says.
It’s the electric utilities that are the real interest-rate proxies, Raftery argues, and “though they’ve come off their highs, it’s not enough to suggest we’ve got major problems with interest rates ahead.”
Andrew Addison, a Franklin, Mass.-based technical analyst, agrees with Raftery that the indexes’ divergence so far isn’t too troubling. He would worry, though, if both the transports and the utilities began plunging at once, he says.
For now, Addison says, the divergences probably just mean that the market overall will stay stuck in a narrow, subdued trading range for a while.
Despite the industrial stocks’ selloff from 3,000, trading volume has been only moderate, a sign that there is no rush for the exits, Addison says.
If you believe that the economy will indeed begin recovering sometime this summer, the market’s nervous churning over the next few weeks or months may give you an opportunity to pick up good stocks at clipped prices.
And if you think the recession will go on much longer than Wall Street now believes, the churning could provide a window to sell before what may ultimately be a steep plunge.
Amgen Split? Not So Fast: As stock of Thousand Oaks-based biotech star Amgen Inc. continues to hover near its all-time high of $136, some shareholders and potential shareholders are hoping for a stock split.
But they’ll have to wait at least until July.
The company has 40 million shares outstanding, and its corporate charter authorizes as many as 125 million shares. But a total of 100 million shares already are “reserved” for warrants and other potential future transactions, the company says.
So Amgen needs shareholder authorization for a slew of new shares before it can declare a split.
A spokesman said it’s under “active consideration” to request greater share authorization at the July 24 annual meeting but that no decision has yet been made.
Briefly: If you want to buy Treasury notes and bonds direct from the federal government at the upcoming quarterly auction, it’s time to send for an application now. The Treasury will sell three-year notes, 10-year notes and 30-year bonds next week.
You can buy direct at no cost to you and get the average yield paid. (The average is determined by how much big investors bid for the securities).
If the three-year notes yield close to what older three-year notes are paying, the annual yield will be around 7.16%. That interest is free of state income tax, though you’ll still pay federal income tax on it.
At 7.16% with the state-tax-exempt kicker, that’s a lot better than what most banks will pay you on fully taxable three-year CDs.
Three-year notes are sold in minimum denominations of $5,000; 10- and 30-year securities can be had for as little as $1,000.
For a Treasury order form, write: Federal Reserve Bank, P.O. Box 2077, Terminal Annex, Los Angeles, Calif., 90051.
A CONFUSED TALE OF THREE INDEXES The Dow Industrial, transportation and utility averages have charted separate paths in recent weeks--a worrisome sign to some analysts who follow technical market indexes. The industrials waffle . . .transportation gains . . .and utilities sink.
