5 Reasons To Watch The Transports

1/26/2015


Investors evaluating whether December-quarter earnings season is a "success" will be watching the Dow Industrials and S&P 500 Index. So will we. But we'll also be keeping a close eye on the lesser-followed Dow Transports, for five reasons:

• Both averages must confirm. Under the Dow Theory, both the Industrials and Transports must reach new highs (for a bull-market confirmation) or new lows (for a bear-market signal). With closes above the December all-time highs of 18,053.71 in the Industrials and 9,217.44 in the Transports, the bullish primary trend would be reconfirmed. If one or both averages fail to reach new highs on a market rebound, the lows reached in the current correction will represent bear-market points. For now, we are maintaining a mostly invested posture, with 89% to 94% of our buy lists in stocks.

• After staging a bigger October-to-December advance than the Industrials, the Transports suffered a bigger pullback. As economically sensitive companies, the Transports could shed light on some of today's big questions. Did the yield on 30-year U.S. Treasury bonds recently hit an all-time low because the outlook for inflation is so mild, or are yields slumping because the economic outlook is so weak? Did oil prices crash because of oversupply or because of weakening demand? No index can answer such questions definitively, but a rebound to new highs in the cyclical Transports would be an encouraging signal.

• The collapse in oil prices, with prices down more than 50% since June and 40% since November, should mean substantial cost reductions for transportation companies. Yet the Transports have made no net progress since early November, suggesting investors may be worried about the impact on spending in the energy sector or the potential for the lower costs to result in price-cutting.

• Based on valuations and near-term profit prospects, it's easier to make a bullish case for the Transports than for the Industrials. If all 20 members of the Transports exactly meet consensus profit estimates for fiscal 2015 and revert to their 10-year norm for P/E, the average would gain more than 20% by early 2016. For the Industrials, the same assumptions translate into a 1% gain. Given the relatively favorable fundamentals, a failure to rally on the part of the Transports would be worrisome.

• We continue to like several transportation stocks, which generally earn high Quadrix Overall scores. Union Pacific ($114; UNP), a Focus List Buy and a Long-Term Buy, earns the highest score in the railroad group. Alaska Air ($65; ALK) and Southwest Airlines ($42; LUV) rank No. 1 and No. 3 in the generally high-scoring airline group. Among smaller stocks, JetBlue Airways ($15; JBLU) is a Best Buy in our sister publication, Upside. Greenbrier ($52; GBX), also a Best Buy, is a leading supplier of railcars and other rail equipment.


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