Rails Wreak Havoc on Dow Theory, Transportation ETFs

Last year, falling oil prices helped make transportation exchange traded funds some of the best performers among industry funds. For example, the iShares Transportation Average ETF (NYSEArca: IYT) surged 25.4% compared to a gain of just 9.8% for the SPDR Dow Jones Industrial Average ETF (NYSEArca: DIA).

That performance emboldened some Dow theorists that believed leadership in the transportation index would give way to a banner year for the blue chips index. However, that theory is being damaged this year by tumbling railroad stocks.

In a note out earlier Tuesday, Rareview Macro found Neil Azous points out that the 5% post-earnings slump being incurred by Norfolk Southern (NYSE: NSC) is infecting other major railroad stocks. That is not good news for IYT. The Dow Transportation Index tracking ETF allocates almost 48% of its weight to “road and rail stocks.”

Union Pacific (NYSE: UNP), Norfolk Southern and Kansas City Southern (NYSE: KSU) are IYT’s second-, third- and fourth-largest holdings, respectively, combining for almost 23% of the fund’s weight. CSX (NYSE: CSX) accounts for 2.4% of IYT’s weight. [Dow Theorists Shaken by Transport ETF]

“Only time will tell if this matters or not, but the divergence between the two indices is going to open up and if prices hold throughout the day there is a high probability the TRAN Index will close decisively below the 200-day moving average or the uptrend line going back to the end of 2012. As a reminder, the last time the TRAN Index dropped below the 200-DMAVG was last October, when the US equity market underwent a technical correction,” said Azous.

The divergence he references is his palpable. Year-to-date, DIA, the Dow tracking ETF, is up 1.3%, but IYT is lower by 5.3%.

According to the Dow Theory, IYT may still plod along as the Dow Jones Industrial Average trades above key levels. The Dow Theory stipulates that if an upward trend in one of its industrial or transportation averages increases above a previous high, it is accompanied by a similar advance in the other index.