A Trade War Could End Transport Bull Market

The Dow Jones Transportation Average reversed at four-month resistance on Tuesday after the Trump administration reversed gears and took the next step in imposing tariffs on Chinese goods. The sell-off reflects growing anxiety about supply chain disruptions that could end the multi-year bull market while signaling a belated response to the breakdown of NAFTA talks and the threat to impose 25% tariffs on imported automobiles.

The transportation sector should turn higher if recent moves are simple negotiating tactics that generate compromise and agreement in the coming weeks. However, if the opposite is true, top sector components could drop 15% to 25% in a few sessions, generating aggressive short sale profits. More importantly, that decline would bring February lows into play, setting the stage for an intermediate downtrend that could last for months or longer.

Railroads and truckers look like top short sale candidates if NAFTA gets set aside because these industries are operating at ground zero in the battle over globalization and imported goods, especially in North America. Meanwhile, airlines and packaging companies could take the biggest hits if a full-scale U.S.-China trade war breaks out, with lower volumes and empty seats reducing revenues. (See also: How to Analyze the Transportation Industry.)

The iShares Dow Jones Transportation Average Fund ETF (IYT) topped out at $168 in 2014 after a multi-year uptrend and sold off to a two-year low at $115 in January 2016. It bounced to resistance after the presidential election and eased into a shallow rising channel that broke to the upside in December 2017. The fund posted an all-time high at $206.73 just six weeks later and sold off, bouncing at range and 200-day exponential moving average (EMA) support near $180. 

Two additional tests at support found willing buyers, while three rally waves failed to pierce horizontal resistance above $195. The fund reversed at that level for the fourth time on Tuesday after a seven-day test, exposing another sell-off to range support. On-balance volume (OBV) has deteriorated since mid-April, pointing to a shrinking supply of buyers while exposing a breakdown that could reach the $160s. (For more, see: Tips for Trading the Dow Jones Transportation Average.)

Kansas City Southern (KSU) operates major north-south railroad routes and has the most to lose if NAFTA goes belly up or trade barriers raise the cost of Mexican-produced parts. The stock hit a five-year low at the end of last decade's economic collapse and turned sharply higher, entering a powerful uptrend that topped out just above $125 in 2013. A 2014 test at that level attracted aggressive sellers, while the subsequent downturn completed a double top breakdown in 2015. 

Buyers returned in 2016 after the stock posted a three-year low, generating two rally waves that stalled at the .786 Fibonacci sell-off retracement level in November 2017. Two breakout attempts have failed since that time, with narrow sideways action generating a holding pattern while politicians decide worldwide trade policy.  A violation of the May low at $104.43 will issue a preliminary sell signal in this scenario, while a break of year-long support at $99 will complete a major breakdown that could reach the upper $70s.

[Check out Chapter 6 of the Technical Analysis course on the Investopedia Academy to learn more about using Fibonacci retracement levels to establish your trading strategy]

American Airlines Group Inc. (AAL) stock stalled within seven points of the 2007 high in the low $60s in 2015 and sold off to a two-year low in June 2016. The subsequent uptrend eased into a rising channel in December 2016, finally reaching 2015 resistance in January 2018. It sold off to channel support in April and broke down, also breaking support at the 200-day EMA. The sell-off ended near the 2017 low a few weeks later, yielding a bear flag bounce that has now reached 50-day EMA resistance. A flag breakdown will set off bearish continuation signals, raising the odds for a decline that fills the July 2016 gap between $31.50 and $33. (For more, see: Key Financial Ratios to Analyze Airline Companies.)

The Bottom Line

Transports have dropped into holding patterns that could generate profitable short sales if the Trump administration follows through on threats to end NAFTA and impose Chinese tariffs. (For additional reading, check out: The Basics of Tariffs And Trade Barriers.)

<Disclosure: The author held no positions in aforementioned securities at the time of publication.>