Transport stocks have long been a leading indicator for equity bulls and, in spite of surging oil prices, this bellwether sector has charged ahead in recent weeks.
One of the tenets of Dow Theory is that a bullish or bearish trend for the Dow Jones Industrial Average is flagged whenever the Dow Transportation Average rallies or declines sharply. This is based on the notion that transport stocks reflect the underlying economy far better than the average company and thus foreshadow prospects for economic growth.
“Dow Theorists are optimistic these days, citing the recent rally in the Dow Jones Transports,” said Jack Ablin, chief investment officer at Harris Private Bank. “Theorists argue that transportation stocks offer an early indication of economic strength and are often confirmed by later-to-react industrial shares.”
The performance of trucking, rail, delivery and airline stocks as measured by the Dow Transports has exceeded that of the S&P energy index since they both set lows in mid-March.
Transports are up 18 per cent while the energy index has rallied 16 per cent. By comparison, both the Dow Jones Industrial Average and the broader S&P 500 have rallied about 9 per cent from their March lows.
Among transport constituents, trucking companies, including Ryder Systems and JB Hunt, have rallied sharply. This suggests that investors believe rising petrol prices can be passed on to the consumer.
Recent consolidation and the prospect of further mergers in the airline industry has boosted transports but they comprise a small segment of the sector. The American exchange airline index has jumped more than 20 per cent in April but is now only 11 per cent higher.
For the equity bulls, the rally in transports amid a surge in oil prices above $120 a barrel reflects long-term faith in the US economy. The combination of aggressive rate cuts from the Federal Reserve in recent months and a fiscal stimulus is expected to boost the economy over the summer.
“Investing in equities anticipates what will happen six to nine months from now,” said Marc Pado, chief market strategist at Cantor Fitzgerald. “Transports are indicating we have seen a bottom in the market and that the economy will do better.”
The rally in transports, however, has doubters who worry that the 20 per cent rise in oil prices from just above $100 a barrel since mid-March will dilute monetary and fiscal stimulus.
The US consumer is already under pressure from falling house prices. Sharply higher food and energy costs are expected to offset much of the $600 cheques being mailed out to individuals by the Federal Government say economists.
“Oil at these levels has to really hurt the economy and discretionary spending,” said Anthony Conroy, head of trading at BNYConvergEx.
The performance of the economy and the fate of the consumer could set the stage for some volatile trading between transports and energy stocks.
“The surge in transports runs completely counter to the spike in crude,” said Mr Ablin. “The challenges facing homeowners and consumers these days make this view overly optimistic. Either way, given its historical relationship with oil, one of these markets is wrong.”
Mr Conroy says the bullishness of investors is puzzling. “Investors are not paying attention and, if we don’t see an upturn in the economy, a lot of people are going to get hurt.”
Mr Conroy also has another reason for doubting the recent rally in stocks. “If there was a lot of volume behind this rally, I would say people have it right,” he said. “Volume is not high enough to suggest we have seen a bottom.”
