April 05, 2010

Dow Transportations, Industrials and Utilities

(Click to enlarge the graphic).

Much has been said regarding the Dow Transportations confirming a continued uptrend, but are the Dow Utilities offering a warning sign?

The three weekly bar charts above plot (left to right) the Dow Transportations, Dow Industrials and Dow Utilities. A 13 and 52 week price channel (dashed and solid red and blue bands respectively) are overlaid on each instrument in the price study. In the indicator section, we've plotted an Accumulation/Distribution line in solid red atop a Chalkin Oscillator in black histogram form. Finally, select support and resistance levels, serving as polarity targets, are plotted using horizontal red and blue dashed lines.

First, lets review the technical tenets this chart represents. Price channel studies are particularly useful in identifying polarity targets, wherein support because resistance and resistance becomes support. Markets naturally gravitate to past significant price levels, and these channels offer perspective. When plotting weekly bars, 13 weeks represents one quarter, and 52 weeks (naturally) one year. Both time periods are considered major intervals in long equity, and form the basis of this week's chart.

Accumulation/Distribution lines are useful in indentifying buying pressure (or lack thereof) during an advance. In a bullish phase, the Accumulation/Distribution line should be rising; during a bearish phase, the line should be falling. The value, bar to bar, of the Accumulation/Distribution line is derived based upon the closing value (between -1 and +1) of a security (relative to its midpoint) multiplied times the periods volume. In basic terms, a close above the midpoint is assigned a positive value whereas a close below its midpoint a negative value. In additive form, the Accumulation/Distribution line effectively ignores the past, and deals in the present (more "in the present" per se).

The Chalkin Oscillator, represented above in histogram form, is merely a Moving Average Convergence/Divergence (MACD) of the Accumulation/Distribution line itself. In essence, the Chalkin Oscillator looks at the past using data in the present, and is derived by calculating the difference between the 3 and 10 period exponential moving average values of the Accumulation/Distribution line. When plotted in histogram form, the Chalkin Oscillator gives us a visual interpretation as to the strength and sustainability of movement in a particular security, as well as a quick reference as to whether we're above or below the two averages themselves. Like MACD, crossing the zero line in the Chalkin Oscillator may be considered either a bullish or bearish signal.

Armed with this information, what does the chart above tell us? Clearly the Dow Transportations are in advance. The index (using the Price Channel) is currently at a polarity price target (prior support has become resistance) near $4,388 and has "room to run" up to $4,571. The Chalkin Oscillator, though diverging with price action from Jul 09 - Dec 09, has made a new relative high and appears to be confirming the move. The Accumulation/Distribution line, however, does appear to have become range bound since Sep 09. A breakout to the long side of the channel would be welcome confirmation of the trend.

Next, the Dow Industrials - perhaps following Dow Theory - has moved on to break through its polarity target near $10,827 with "room to run" to $11,634 (once again, derived from the Price Channel study). The Chalkin Oscillator is interesting, however from a technical point of view. While there was modest divergence in Q4 09, one could argue the oscillator itself has been stagnant during the advance since Sep 09. Indeed, while the Accumulation/Distribution line rose across the same period, a divergence between the two perhaps foretold trouble heading into Jan 10. As with the Dow Transportations, a breakout to the high side would also be welcome confirmation.

Lastly, however, look at the Dow Utilities. It's hard to find the same enthusiasm in this chart. Rather than first looking at the current price action, look to the far left of that chart - back to price action in CY 07. While the price (of no consequence to the argument) is not plotted, a clear head and shoulders pattern formed during the rally in Dow Transportations and Industrials into Oct 07. This is troubling on two counts: 1) the index itself appears to be forming the right shoulder of a similar head and shoulders into the current advance in its sister indices, and 2) current price action in the Dow Utilities appears to be range bound between 360 and 388. The Accumulation/Distribution line has broken below prior support, and the current rally in the Chalkin Oscillator appears weak.

One could argue that the Dow Utilities might foretell a coming rise in interest rates. The entire technical community - if not the fundamentalists themselves - has seemed to remark Treasuries appear on the verge of a bubble. The US Dollar continues to strengthen against all odds, even as the price of Crude Oil nears $90 per barrel. Could all of this spell rates are soon to be on the rise? And if so, what does that mean for our markets? Technicians can draw their own conclusions, but a quick review of the 2, 5 and 10 year US Treasury futures shows a break down in trend that is cause for alarm. How this plays out in the commodity markets is a conversation for another day, but for now all eyes should be on price action in the Dow Utilities as we look for clues as to the road ahead.

Jeffery E. Lay, CMT
President
Talon Eight, LLC

Disclaimer: This post is intended solely to disseminate information, and is not, and shall not be construed to constitute financial, investment or other similar advice. All posted material should be independently verified for accuracy and current applicability. Readers of this post are referred to the Risk Disclosure for further information.

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