One of the six tenets of the Dow Theory is that indices must confirm each other. Charles Dow broke the market down into two indices: the Dow Jones Industrial Average and the Dow Jones Transportation Average. So, for a trend in the markets to remain intact, both major averages must be moving in the same direction. 

The reason that Mr. Jones broke down the market into industrials and transports is because of this basic philosophy:

If the business is strong, profits will be rising. And, if profits are rising, manufacturing should increase to meet the sales demand. If production is up, then there will be more goods to ship to consumers. 

This is why Mr. Jones looked to the transports to validate the industrial trends. 

Now granted, America has changed quite a bit since Mr. Dow was alive in the latter half of the 19^th century. His theory was based upon the economics that arose from the Industrial Revolution. However, the general principles of his work still apply today which is why market analysts still use his theories to spot trends. 

The Dow Jones Industrial Average hit new all-time highs in late September. And although some analysts like to talk about narrow leadership in the markets, when I look over the Dow components, I see a lot of strong companies doing very well. 

The Dow Jones Transports Average is trading similarly well. The rails are trading at all-time highs. Boeing is reaching new highs in the aerospace industry. And although the major logistics players, FedEx (FDX) and United Parcel Service (UPS) have struggled a bit in 2018 after hitting peaks during January’s exuberance, when you take a step back and look at their long-term charts, they’ve performed exceedingly well in recent years as well. Rising fuel costs have put a bit of a damper on the airlines, but overall, this index is sitting near all-time highs too. 

This is what has led me to the banks. When you look at the Dow 30, it’s clear that the financial components within the index are the major underperformers. To me, this doesn’t make sense. I understand that the financials suffered mightily during the Great Recession and many investors are still wary of these names. However, if the broader economy is as strong as the Dow Theory seems to suggest, then investors shouldn’t be overly cautious regarding this sector. 

Actually, you’d think it would be the other way around. A strong economy should result in consumer spending, loan growth, and rising interest rates. All of these things are great for the banks. 

Furthermore, when looking at the big banks, their fundamentals have been improving. For the most part, sales and profits are trending upwards. Management within the industry is returning massive amounts of excess cash to shareholders. The combination of increased dividends and stagnating share prices have led to dividend yields above the 5-year averages of many of the well-known money center banks. Buyback authorizations in this space are in the billions as well, which should help profitability metrics continue to grow down the road.   

I’m not going to sit here and attempt to make bold macro calls on the market. To me, that’s a fool’s errand. It’s important to note that when we hit a recession again (and it’s only a matter of time before we do) it’s likely that the banks will perform badly and their dividends could possibly be put at risk. But, the same thing could be said about a myriad of stocks in the market and generally, I’m happy to own a well-diversified mix of stocks because I don’t have any idea when or where the next market crash will occur. 

Market crashes usually arise from black swan events. If you believe in efficient markets, any catalyst of a major change in sentiment has to be unpredictable. Otherwise, it would be discounted and wouldn’t lead to volatility. However, as an income-oriented investor looking for value in the markets, it’s difficult for me to ignore the banks. 

So, if you’re looking for passive income, you like buying low, rather than high, you believe in the strength of the U.S. economy and don’t see a recession on the horizon in the short-term, and maybe you’ve got a just a little bit of a contrarian in you, then maybe it’s time to ignore some of the popular trades in the market and take a closer look at the banks.