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  • Writer's pictureMichael McCracken CFP®, ChFC

Markets and Volatility… Transports may be telling us something!

Well, this year has been a tricky environment for investing while also managing risk at the same time. This is an important caveat because looking at the S&P 500 or the Nasdaq, it would appear that investing is easy – just buy those indexes and you’ll be all set. The reason we added, “while managing risk” is because in our opinion those indexes do not appear to be properly accounting for much if any of the risks to the outlook. Since November of 2023, there hasn’t been a pullback of greater than 5% in the S&P 500, that stat represents an unusual level of calm especially given the macroeconomic and geopolitical environment. When looking under the hood, it’s a little bit deceptive because the average stock is not doing nearly as well as those indexes might have you believe. A big piece of that is due to the AI hype, and most specifically NVDA – in fact NVDA stock alone accounts for over 40% of the move in the Nasdaq 100 this year. Link Meaning a whole lot of the gains are counting on a single company that is riding a wave of momentum in truly incredible fashion.

Let’s review where the year started compared to where we are today:

Start of Year:

  1. Market was anticipating six 25 basis point (0.25%) rate cuts in 2024.

  2. Market and Fed were expecting inflation to drop steadily.  

  3. 10-year treasury rates were around 3.8%-3.9% to start the year.

  4. Unemployment rate was 3.7%.

  5. Weekly Initial Unemployment Claims for the US were 198,000.

  6. January Consumer Sentiment – 79.00.


June 2024:

  1. Fed’s current dot-plot anticipates only one 25 basis point rate cut in 2024.

  2. Inflation surprised to the upside multiple times, proving stickier than expectations. May inflation was encouraging, but the Fed seemed to take the May readings as outliers, similar to the earlier hotter readings.

  3. 10-year rates currently 4.2% but were as high as 4.73% in April and May.

  4. Unemployment rate now 4.0%.

  5. Weekly Initial Unemployment Claims for the US most recently are 242,000.

  6. June Consumer Sentiment – 65.60.

After a great run for the market and our portfolio in the 4th quarter of 2023, we began to position our portfolio more defensively in mid-January. We believed the market was incorrectly pricing in the outlook for interest rates and inflation and as a result, would likely have a pullback as inflation proved to be stickier and thus interest rates would need to move higher as a result of pricing out the anticipated six rate cuts. Whether the pullback would be mild or more severe we weren’t sure. As you can see from the points above, inflation came in hotter than expected and rates moved up significantly. However, the S&P 500 and Nasdaq have skated through every new piece of macroeconomic news and additional geopolitical risk as though it weren’t a factor. This has been puzzling for us and is why we say it’s been a challenging year for managing risk – because the market is behaving like there aren’t any risks, however, we know that isn’t the case.

We can speculate on it being an election year and a certain level of politics can come into play, but it is strange for the market to be embracing only the good news and in our opinion, seeming to shrug off or ignore most of the bad news. Couple that with very conflicting economic data – for example the jobs data from the Bureau of Labor Statistics (BLS) in May showed 272,000 new positions were added in the Nonfarm Payroll report. Whereas in another BLS report – the Household Survey – a net loss of 408,000 jobs were reported for May. Link Yet if you turn on the investing news, everyone talks about how strong the labor market continues to be, apparently embracing one report and ignoring the other? We believe one of the metrics in the Nonfarm Payroll report may be overstating the jobs creation. That metric is the “Birth-Death Ratio”. The ratio is used to estimate the net number of jobs created from the birth (opening) of new businesses relative to the net number of jobs lost from the death (closing) of businesses. These estimates are based on 5-year trends and so this ratio is useful most of the time but quite flawed at turning points, because it doesn’t catch the turning point until well after the fact. If the economy is turning towards a recession and businesses are closing faster than the 5-year trend and others aren’t opening as quickly as the 5-year trend the “Birth-Death Ratio” could show net additional jobs when there are in fact net job losses… you can see how this could result in inaccurate data at turning points. Link

We have been highlighting some of our concerns to help you understand why we have positioned our portfolio so defensively for much of this year, admittedly to our detriment as we’ve missed out on some gains that the indexes have been enjoying. It has certainly been discouraging to miss out on some of these gains, however, we still believe it has been for good reason and we’d like to add some meat to our analysis by showing you something called Dow Theory, or the Down Transport Theory.


What is the Dow Transport Theory?

First developed over a century ago – it essentially boils down to using multiple indexes to confirm a trend. When this theory was first developed by Charles H. Dow, he used the two indexes he and his partners invented, the Dow Jones Industrial Average and the Dow Jones Transportation Average. To summarize the theory, before declaring an uptrend or a downtrend it must be confirmed by both indices – a move to new highs in one index would need to be confirmed by the other index and vice versa. The idea being that if the industrial companies are producing more, etc. and those stocks are trending up, the transportation stocks should also look good because they would be moving all those goods around the country. However, if hypothetically one index is moving up and the other is moving down, there needs to be some kind of reconciliation before a true trend can be confirmed.

For our purposes in this blog, we are going to be highlighting the Dow Jones Transportation Average (DJT) relative to the S&P 500 (SPX). We are currently witnessing a divergence that over the last 70 years or so, doesn’t typically end well. Read on to find out what we’re talking about.

Prior to several significant market corrections in history, the DJT provided a warning ahead of time. A divergence in stock performance of the DJT compared to SPX where the DJT started moving lower, while the SPX continued making new highs before later following the DJT lower. By our assessment, this makes the DJT a reliable leading indicator.

Here are some examples:

As you can see in the chart above, in 1999, months ahead of the dot-com crash, the DJT signaled an economic slowdown was coming as it headed lower while the SPX kept moving higher. There are examples of this same concept playing out ahead of the January 1973 market selloff of 50% and the 20% market pullback in the 1990 recession.

Why are we bringing this up? Because a similar divergence seems to be playing out right now.

Above is the price % change for both the DJT and SPX from January 2020 to early June 2024. We’re showing you an expanded time frame so you can see how these tend to move together over time. You can probably see the divergence we referenced that has developed in 2024. Let’s zoom in.

As you can see, in 2024 there has been a more than 20% gap in performance between the SPX and DJT. With SPX gradually making higher highs and the DJT gradually making lower lows.

What does this mean?

As we mentioned before transportation stocks are a leading indicator. When the economy begins to slow down, less people are travelling and spending on goods and so companies that do the transportation of people and goods are one of the first areas to take a hit. That doesn’t mean there is a market crash that will materialize in the next week. However, it is a major concern and throughout history has been a leading indicator for several significant market selloffs. This is another one of the reasons we have been so conservative with our portfolio this year. This signal also happens to be coming at a time when a majority of investors are no longer factoring in a recession in the next 12 months. Link This elevates our concern because it means a majority of investors will be caught offside if a recession materializes sooner than later. It’s also worth noting that Warren Buffett is now sitting on over $180 Billion in cash at Berkshire, his highest ever cash balance and says he doesn’t see anything worth investing in in today’s climate. Link

We are not sharing all of this with you to create anxiety, but rather to keep you informed to the best of our ability and communicate why we are positioned in a defensive allocation at this time. We believe a correction in the market would be appropriate at such stretched valuations and at the end of the day provide a much healthier risk-reward opportunity for us to invest in a more aggressive way.


Authored by: Michael McCracken CFP®, ChFC and Jeffrey Gardner, Financial Advisor The information presented above has been prepared for informational purposes only and the commentary represent the opinions of the author and are subject to change at any time due to market or economic conditions or other factors.


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