Dog in the Night
The ‘dog in the night’ is, conceptually, the contra of the canary in the coalmine. In the early twentieth century, when coal was still king, miners used to take a canary down the shaft and use it as a live and primitive early-warning system. Canaries are highly sensitive to dangerous gases which might be odourless for humans, so if the birds took ill or actually dropped dead, that signalled danger. The dog that did nothing in the night, on the other hand, was a fictional creature in one of the Sherlock Holmes stories. It ought to have barked when intruders entered the house, so its failure to do so tipped off the great sleuth that the intruder in question must have been someone it knew and regarded as friendly.
Traders in financial markets are always looking for effective canaries – early signs that something is wrong, tipping them off to get out in good time, before the whole thing blows up or collapses. But one of the most extraordinary features in the markets recently – and there has been no shortage of these -has been the disconnect between the equities and debt markets: the debt market is the epicentre of the financial crisis, and large chunks of it are paralysed or badly malfunctioning, while the equity market is suffering mostly collateral damage.
More remarkably, the equity market as a whole has not suffered heavy losses; once you get past the financial sector and some consumer-oriented sub-sectors in the US, the rest of the market is in fairly good shape. Given that everyone now accepts that there is a major financial crisis underway, and at least a mild recession of not a prolonged and nasty one – given all that, it seems surprising that the equity markets haven’t suffered far worse falls.
But within that generally extraordinary feature is one aspect that appears completely weird. The Dow Jones Transportation Index has regained most of its losses from the second half of last year and is performing very well. Since the companies that comprise this index are very sensitive to the level of economic activity, they should have been leading the overall market lower, not acting as one of its bulwarks. In other words, the market’s traditional canary has turned into a dog in the night.
There are two ways of analysing the markets – fundamental and technical. Fundamental analysts look for rational economic answers to market phenomena, whether in the macro economy or in developments at specific companies. In the context of the Transportation Index, the macro picture demands that they fall, and the constant rise in oil prices demands that airline stocks, in particular, take a nose-dive. But that’s not what’s been happening; one reason is that Warren Buffet and others have been heavy buyers of railroads (although not of airlines..), but it’s still rather perplexing.
Technical analysts, however, don’t ask why and don’t much care about the reasons. They just follow the stocks and the indices and decide on the basis of the charts. For many people, this is voodoo, but it actually works much better than most fundamental analysis, as a basis for investment decisions. Furthermore, for technical people, the Transportation Index has special significance, because it is a key component of Dow Theory. This was invented by Charles Dow, of Dow-Jones fame and, to boil it down to its barest essentials, says that moves in the Dow Jones Industrials Index (the one everybody watches and talks about) must be ‘confirmed’ by similar moves in the Transportations. Yet the ‘Trannies’ made their low for the last year on January 18, when their index briefly fell below 4,000; the Industrials also reached a lowpoint at that time, but this index made a new and lower low in March – which the Transportation Index completely ignored! The failure of the ‘Trannies’ to ‘confirm’ means, according to the late Mr Dow and his followers, that there is no bear market, whatever indications there may be to the contrary.
The Transporatations Index has actually been very strong of late, trying time after time to break above 5,000, although without success. But on Wednesday, when oil prices surged to new records (yet again), the Trannies finally took notice, falling by 3.5% on the day – far more than the Industrials index. Whether that is a transient event or whether the Transportation Index has reverted to being a canary – albeit a very tough one – remains to be seen.