Transports Versus The Fed

9/24/2012


After the U.S. stock market closed on Sept. 13 — the day stocks surged on the Federal Reserve's announcement that it would use freshly created money to buy $40 billion of mortgage-backed securities every month until the economy improved — trucker Werner Enterprises ($22; WERN) warned of disappointing September-quarter earnings.

A broad decline in the trucking group held the Dow Transports to a minimal gain on Sept. 14, and by Sept. 19 the average was lower than where it stood before the Fed's announcement, partly because a profit warning from FedEx ($87; FDX) pushed airfreight stocks lower. After the close on Sept. 19, railroad Norfolk Southern ($73; NSC) also warned.

Drawing big-picture conclusions from short-term market moves is usually a mistake. But the Transports' reaction to the announcement from the Fed and the lower-than-expected earnings merits attention, for the poor news on profits is unlikely to be limited to transportation companies.

For the September, December, and March quarters, all 10 sectors of the S&P 500 Index except financials have seen consensus profit estimates reduced since July 1, according to Thomson Reuters. Negative earnings preannouncements for the September quarter are outrunning positive preannouncements by a 4-to-1 ratio, the worst showing since 2001.

After a 2% year-to-year decline for the September quarter, earnings for the S&P 500 Index are expected to climb 10% for the December quarter and more than 11% for full-year 2013. The predicted December-quarter rebound depends on easy comparisons for the financials and materials sectors, and investors are rightly skeptical regarding a return to double-digit growth in 2013.

Much of the profit growth since the end of the recession has reflected cost-cutting and gains in overseas sales. But Werner Enterprises warned that costs are climbing faster than revenue per mile, while FedEx blamed a slowdown in global trade.

Conclusion

Are warnings from two transportation companies reason enough to abandon stocks? No. But the Dow Transports' stubborn refusal to confirm new highs in the Dow Industrials is cause for concern, as the tailwind provided by money-printing from central banks will peter out if investors begin to anticipate an extended slump in corporate earnings.

Historically, the Transports have been a good barometer for the health of the U.S. and global economy. A close above 5,368.93 in the Transports would reconfirm the bullish primary trend under the Dow Theory. Pending such confirmation, we intend to hold 10% to 15% of equity portfolios in a short-term bond fund. For new buying, Express Scripts ($63; ESRX) represents a top pick.


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