Transports Stuck In Low Gear


Helped by favorable readings on the U.S. economy and U.S. banking sector, the Dow Industrials and S&P 500 Index powered to fresh multiyear highs. But the Dow Transports, which have underperformed year-to-date after lagging in 2011, have yet to surpass their 2011 all-time high of 5,618.25 and remain 3% below the Feb. 3 close of 5,368.93.

While we intend to keep a close eye on the Transports, the bullish trend remains intact. Our buy lists have about 10% in a short-term bond fund and 90% in stocks.

Yellow flag

Confirmation from both the Industrials and Transports is central to the Dow Theory, as more than a century of history suggests the market is on stronger footing when both averages are reaching significant highs. As we see things, both averages reached significant highs in December, when the respective October highs of 12,231.11 and 5,025.09 were surpassed.

A correction from current levels would be consistent with an ongoing bull market, and it's worth noting that the Transports are up more than 28% from the Oct. 3 closing low. Still, the continued underperformance of the economically sensitive Transports represents a yellow flag.

Are the Transports lagging because of surging fuel costs and slumping coal demand, or because of more general concerns regarding the global economy? Only time will tell for certain, but keep the following in mind as you watch the averages:

• The Dow Jones Transportation Average, a price-weighted average of 20 stocks, is not providing a misleading picture. Capitalization-weighted indexes like the Dow Jones U.S. Industrial Transportation Index have charted similar courses. Four notable groups in both benchmarks — airlines, air freight, railroads, and trucking — have underperformed so far in 2012.

• Year-ahead expectations for profit and sales growth in the transportation sector remain above those for the overall market, potentially setting the group up for disappointment if the slowdown in China and other emerging markets worsens.

• The air freight group, with the biggest weighting in the Dow Jones Transportation Average and cap-weighted transportation indexes, is crucial. Unlike the other heavyweight group, railroads, air freight is not burdened by weak coal demand. More than most groups, air freight is a bet on continued growth in Asia and U.S.-Asia trade.

• Airline stocks represent less than 3% of the sector's total value but more than 8% of the Dow Transports, partly because of a huge rally in Alaska Air ($35; ALK) since mid-2009. With so much riding on the ability of U.S. consumers and businesses to withstand higher fuel prices, airlines are worth watching.

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