Dow Transports a Bad Sign? - Cook`s Kitchen

By Zacks | August 31, 2012 AAA

The major indexes are sitting, apparently comfortably, just below highs not seen in over 4 years, since before the market meltdown of 2008.

But one sector index has some investors and traders worried: the Dow Jones Transportation Average (DJTA). Proponents of "Dow Theory" believe that bull markets are confirmed by the "Transports" showing strength at the same time as the Industrials, for reasons concerning both economic fundamentals and technical price analysis. Below is a chart showing this weakness.

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Dow Theorists say this is a dire warning and can cite "numerous times over the past 5 years where Dow Theory Non-Confirmations showed us that the market was in a danger zone of topping," says Chad Karnes writing for ETF Guide. "Every single time this signal occurred the broader market soon fell."

Given this concern, it's a good idea to take a look at the "trannies" in terms of the economy and price. Below is a list of the top holdings of an ETF which tracks the DJTA, iShares IYT. The DJTA index includes 20 companies, but as you can see, these top ten make up nearly 70% of the weighting.

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It's probably not hard to guess who has been dragging on the Transports: the air-freight shippers like UPS and FedEx, who combined comprise 16% of the index, and the airlines which make up only 11% in total. United Parcel Service (UPS) and FedEx (FDX) both have given subdued outlooks this year about their business, domestic and global.

But there is also some underlying strength which must be looked at before one rushes out (or to their PC, rather) to sell stocks.

Railroad businesses and trucking companies have been doing well and this is showing up in the Zacks Rank. With rising revenues and profits, earnings surprises, and the consequent earnings estimate revisions (EER, the bread and butter of the Zacks Rank), these industries seem to speak of healthy economic activity which has only been somewhat reflected in equity prices.

Below is a table with a focus on companies involved with rail transport. I've included UPS and FDX as well to highlight the importance of the Zacks Industry Rank.

With over 260 separate industries in the Zacks classification universe, the cumulative Rank of stocks within each group create a very handy aggregate ranking of industry performance. Generally, industry groups in the upper third signify healthy growth.

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One thing to note regarding price is that Union Pacific (UNP) and Norfolk Southern (NSC) are 20% of the DJTA and these stocks have done well since the June lows. If it weren't for them, the Transport Index would be stuck in a very low gear.

Will the Transports find their footing and rally with the Dow? Or are they a harbinger of a broad market decline around the bend?

Regardless of the indicator value of the Transports, it pays to look at some of the industries and stocks doing well within it anyway. Rails seem to be signaling something positive about the economy that isn't always obvious. It could be energy related, or it could be rail improvement projects, or both.

The next step in finding out should be looking at the Zacks company reports and earnings estimate trends for the 3 equipment and leasing companies in particular, Wabtec Corporation (WAB), Trinity Industries (TRN), and American Railcar Industries (ARII).

Kevin Cook is a Senior Stock Strategist with Zacks.com

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