Transports Slump On Profit News

6/27/2016


The major averages have been caught in a holding pattern, reflecting valuation concerns and worries regarding Britain's vote on whether to leave the European Union. For now, as a partial hedge, we're holding 16.5% to 17.2% of our equity portfolios in a short-term bond fund. A rally that lifts the Dow Industrials above 18,096.27 and the Dow Transports above 8,109.19 would be bullish — and a reason to boost our equity exposure.

Freight volumes remain sluggish

For the S&P 500 Index, the June quarter is expected to be the fifth consecutive period with lower year-to-year earnings and the sixth consecutive period of lower revenue. Yet the index trades at more than 16 times expected year-ahead earnings, above the 10-year norm near 14, according to FactSet.

One mitigating factor: Much of the market's overvaluation is concentrated in the safest stocks, like consumer staples and utilities. As shown on this page last week, the 40% of S&P 1500 stocks with the least-volatile share prices trade at substantially higher price/earnings ratios than their norms since 1994. By comparison, the other 60% of stocks trade roughly in line with their historical norms, on average.

With an improved outlook for corporate earnings growth, investors would have incentive to look beyond the slow-growth, bond-like stocks that have led the market this year. That is one reason to keep a close eye on the market's reaction to June-quarter earnings season, which begins in the second week of July.

For the same reason, we keep a close eye on the Dow Transports, which are highly sensitive to the economic outlook. So far, early reads on the June quarter for the transportation sector have not been encouraging.

• On June 20 and June 21, truckers Covenant Transportation ($18; CVTI) and Werner Enterprises ($22; WERN) warned that June-quarter earnings would fall short of consensus estimates because of sluggish freight volumes and higher costs.

• Canadian Pacific ($127; CP), Canada's second-largest railroad, warned on June 21 that June-quarter earnings would be well below expectations, reflecting declining shipment volumes.

• On June 21, FedEx ($157; FDX) delivered better-than-consensus earnings on June 21. But the stock slumped 4.5% on the report, reflecting disappointing guidance for the year ahead.

Conclusion

The Dow Transports, historically a good barometer for the more cyclical parts of the economy, merit close attention. For new buying, we're finding opportunities among somewhat cyclical shares with solid profit outlooks, including Mohawk Industries ($195; MHK) and D.R. Horton ($31; DHI).


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