Say Yes To Transport Stocks

6/9/2014


Even though the combined stock-market value of the 30 stocks in the Dow Jones Industrial Average is more than 11 times that of the 20 stocks in Dow Jones Transportation Average, the Dow Theory assigns equal importance to the two averages.

That's partly because the railroads were such an important part of the stock market when the Dow Theory was developed by Charles Dow and William Hamilton in the three decades after 1900. But it's also because subsequent market watchers have found it's tough to make money owning U.S. stocks when the more economically sensitive parts of the market are deteriorating — and shares of transport companies remain among the best leading economic indicators.

Still, the Dow Jones Transportation Average is a price-weighted average of 20 stocks, so we always consider whether it may be sending a misleading signal. Some timely questions:

Are broader indexes of the transportation sector confirming the strength of the Dow Transports, which have gained 9% this year after a 39% gain in 2013? Yes, the Dow Jones Industrial Transportation Group and the S&P 1500 Transportation Group, both capitalization-weighted, reached all-time highs in early June.

Are most transport-related industry groups participating in the rally? Yes, all the industry groups represented in the Dow Transports have rallied to new highs in recent trading.

Are other cyclical groups confirming the rally? Yes, the Morgan Stanley Cyclical Index, an equal-weighted average of 30 economically sensitive stocks, reached all-time highs in early June. So did the S&P 1500 industrials and basic materials sectors.

Do the Transports have more upside potential? Yes, if consensus profit forecasts for the stocks are reasonable. If all 20 Dow Transports exactly meet their next-year profit estimate — and all 20 stocks trade at a P/E equal to their 10-year historical norm — the average would trade at 8,904 in early 2016, up about 9% from current levels. Based on current-year profit estimates and 10-year norms for P/E, the average would trade at 7,619, down about 6%.

Do any transportation stocks represent attractive picks? Yes, Alaska Air ($100; ALK) and Union Pacific ($197; UNP) are both Focus List Buys and Long-Term Buys. Norfolk Southern ($99; NSC) is a Long-Term Buy. Air Lease ($42; AL), which leases airplanes to commercial airlines, is a top pick of our small-stock sister publication, Upside.

Conclusion

While not cheap, the Dow Transports are benefiting from broad-based strength in cyclical stocks. Both the Industrials and Transports reached all-time highs earlier this month, and the Dow Theory is squarely in the bullish camp. Our buy lists have 97% to 99% in stocks.


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