Recovery Doubts Hit Transports

6/23/2009


After trading sideways for most of June, stocks have dipped amid doubts regarding the economy. While the market’s near-term direction will hinge on economic news and interest rates, a meaningful pullback in the averages seems likely in coming months. As a partial hedge, we’re keeping about 30% of our recommended equity portfolios in Vanguard Short-Term Investment-Grade ($10.19; VFSTX), a relatively low-risk bond fund.

Too far too fast?
The Dow Transports have dropped on weakness in airfreight, railroad, and trucking stocks. Even before the recent drop in the Transports, some commentators had expressed worry about their inability to move above their May 6 closing high of 3,404.11 and confirm new highs in the Dow Industrials.

Such worries have some validity, as the failure of one average to confirm new highs in the other average can signal a heightened risk of a market pullback. But the Transports’ decline from May 6 to May 13 was not deep enough or long enough to qualify as significant, and a near-term rebound above 3,404.11 would not represent a bull-market signal.

For a return to the bullish camp, two things must happen. First, both averages need to suffer significant corrections, with at least one average holding above its March low. Second, both averages need to close above the highs established in the rallies since March.

In general, significant corrections retrace one-third to two-thirds of the preceding rally over three weeks to three months. Based on this rough rule of thumb, significant corrections of the rallies since March would bring the Industrials to 8,050 to 7,300 and the Transports to 2,985 to 2,565.

With investors worried that stocks have come too far too fast, near-term action in the Transports will be watched closely. Despite very weak fundamental data from the transportation sector, the Transports are trading more than 48% above their March low.

Analysts are still slashing 2009 and 2010 profit estimates for airfreight and railroad companies, and railcar loadings continue to slump. FedEx ($50; FDX), the nation’s second-largest package shipper, recently issued a disappointing forecast for the August and November quarters.

Conclusion
While stocks tend to rally in advance of improvement in the economy, the market’s most recent rally is likely to falter unless investors begin to see concrete signs of revival. Subscribers should maintain significant cash positions. Top picks include Comcast ($14; CMCSA) and Hospira ($34; HSP).


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