Transports: Canary in a Coal Mine?

08/03/2017 2:57 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

Solid earnings reports have pushed the Dow Industrials to all-time highs in recent trading, but the Dow Transports have slumped on disappointing air-freight, airline, and railroad results, notes Richard Moroney, editor of Dow Theory Forecasts.


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While the divergence between the two averages heightens the risk of a near-term pullback, the Dow Theory remains in the bullish camp. Our buy lists have 94.8% in stocks, with the remainder in a short-term bond fund.

Nevertheless, the transports’ divergence is a worry. In early July, when the Transports finally confirmed the Industrials by reaching new highs, we warned that “it is not unusual for the broad market to pull back following a fresh confirmation.”

What is unusual is the extreme divergence between the two averages since the confirmed new highs. Since the Industrials and Transports both closed at all-time highs on July 14, the Transports have moved lower in 10 of 13 trading sessions.

The Transports have slumped about 600 points, or 6%, since July 14, retracing nearly two-thirds of their advance from the low reached in May. Meanwhile, the Industrials have gained nearly 2%, closing above 22,000 for the first time.

Has anything really changed, or is the divergence since July 14 just statistical noise? That is a tough question to answer in real time, but there’s no doubt that sentiment toward transportation shares has dimmed.

* Airline stocks slumped on disappointing forecasts for third-quarter unit revenue, along with signs of slightly faster-than-expected capacity growth.
* All the major U.S. railroad stocks have dropped since posting second-quarter results, even though they mostly reported better-than-consensus earnings.
* Similarly, FedEx (FDX) and United Parcel Service (UPS) fell after UPS beat on earnings and sales but failed to lift its full-year guidance.

Historically, the economically sensitive Transports have often served as a canary in the coal mine, warning investors of a deteriorating outlook for the economy and corporate profits. At the same time, the Transports are inherently volatile stocks, and to see them pull back on earnings news after a big run is not surprising.

For now, with the broad market still showing decent action, we’re inclined to view the divergence between the averages as a yellow flag — not as a sell signal. Our buy lists remain nearly fully invested, with an emphasis on technology, financial, consumer-discretionary, and health-care stocks.

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