Watch the transports

9/1/2008


Reflecting worries about the global economy and U.S. financial sector, stocks have been volatile. Subscribers should look for opportunities one stock at a time, hold 15% to 20% of equity portfolios in cash, and watch the averages. With closes below the July lows of 10,962.54 in the Dow Industrials and 4,653.13 in the Dow Transports, the Dow Theory would shift to the bearish camp — and our hotline would be updated with specific instructions for raising cash.

Leading indicator
With conditions in the financial sector deteriorating, Wall Street’s keen interest in financial stocks is understandable. The bearish case for stocks still depends importantly on housing and financials — and the extent to which problems in these sectors will affect the broader economy. While brokerage stocks are trading at or near 52-week lows, the overall financial sector remains more than 15% above its July lows.

The Dow Transports, however, have moved close to five-week lows and are roughly 7% from the July closing low of 4,653.13. The action of the Transports is always critical to Dow Theorists, as the Dow Theory’s verdict on the primary trend only changes when the Industrials and Transports both reach significant highs or both reach significant lows. However, the Transports deserve particular attention today, for at least three reasons:

Stocks in the trucking and airfreight industries, which should benefit from a sustained drop in fuel prices, have weakened in recent weeks despite a drop in oil prices. While the railroad group has held up well, the fact that most groups in the Transports are under pressure is worrisome.

Since 2003, the Transports have been a leading and highly effective barometer. The Transports led the way during much of the 2003-to-2007 bull market, then turned lower in mid-2007, ahead of a broader market downturn.

Optimism regarding overseas growth — and U.S. companies’ ability to capitalize on this growth — has been an important source of support for stocks. Transportation companies have benefited greatly from the increasingly integrated nature of the global economy, and a move to new lows in the Transports would suggest this favorable dynamic has been halted.

Conclusion
A breakdown below the July lows in both the Industrials and Transports would suggest that stocks have further to fall. For now, subscribers should hold 15% to 20% of equity portfolios in a money-market or short-term bond fund while emphasizing such reasonably valued growers as Accenture ($40; NYSE: ACN) and Harris ($52; NYSE: HRS).


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