Can Equity Indices continue to Move higher without Confirmation of the Transport Index?

That is one question which came up quite a few times among traders in the past few weeks.

The argument against this portion of the Dow Theory is that the U.S. economy is less dependent on manufacturing and heavily driven by the service sector.

That is true.

And here is an argument for the need of trend confirmation.

The (global) economy is driven by the service sector, one thing that traders and investors agree on but consider the following:

Once a company from the service sector decides to expand (and therefore contribute to economic growth) the company needs to at least purchase additional equipment and most of the time upgrade or build additional office space.

Even if there is no need to build additional office space the company will need to buy additional equipment and upgrade the existing office (desks, chairs, computers, phones, etc.) in order to accommodate additional employees and get those employees ‘operational’.

So, once a company decides to expand and orders the additional equipment required that equipment needs to be moved from point A to point B which requires either trucks, rail, air or ships and therefore for the economy to expand or be considered healthy the Dow Jones Transportation Average needs to gain as it is made up of companies which move ‘things’ around and that indicates strong demand and an expanding economy.

Constituents of the DJTA also indicate demand for private purchases as more consumer order on-line. Overall, the DJTA is a decent indicator for the overall strength of the economy.

If the constituents have a bullish outlook, due to increased demand for the services offered due to an increase in economic activity, investors buy those equities and therefore the DJTA expands. However, if companies indicate lackluster demand it indicates that the economy is slowing down and the DJTA contracts.

So, should traders and investors focus on the DJIA to get back to the 14,000 mark and above?

No, as any further upward movement in any of the indices but especially the DJIA won’t be sustained unless the DJTA will move in unison with the broader market.

The DJTA is impacted by high energy prices but strong demand for the service offered by constituents of the index would make up for the increased operating costs and most companies already have a fuel surcharge in place to limit the impact of high energy prices.

Regardless if the economy is based on the manufacturing sector or driven by service sector there will always be the need for ‘things’ to be moved around and therefore trends need to be confirmed in order to be sustainable.

One more thing to add:

The Russell 2000 has not kept up with the recent gains and could also signal that the rally since the Fed Rate Cut may be short-lived.

Certainly when the service sector expands it requires new hardware - but much of this is supplied on thin profit margins anyway - cf consumer electronics - and much of this seems manufactured overseas, or via overseas brands.

I would have thought software purchases were bigger than actual hardware costs - certainly in my own little office, we've spent far more on software than actual manufactured goods.

It is true that many things are manufacured overseas and/or on low parofit margins distribution channels but 'supplies' still need to be moved from place to place.

I think that the DJTA needs to confirm the trend of the other indices in order to keep any upward movement 'valid'. It certainly doesn't look like it at the moment.

Some of the DJTA components have decent global exposure and they report that demand is not as good as the equity markets want them to be.

For some reason the majority of investors do the same mistakes they did in June and July and want to ignore all the bad news in the pipeline.

We'll see what will happen on Q4. Holiday shopping season may not be as strong as expected.