Transports On The Verge


The Dow Industrials have extended their run into record territory as earnings-reporting season heats up, but the Dow Transports have yet to surpass the April 20 high of 8,109.19. A close above that level would put the Dow Theory in the bullish camp — and trigger an increase in our recommended equity exposure, probably to at least 90%. For now, our buy lists have 80% to 81% in stocks, with the remainder in a short-term bond fund.

Encouraging start

So far, June-quarter earnings season has been mildly encouraging. The percentage of companies exceeding consensus estimates is in line with recent norms, and the quarter should mark the fifth consecutive year-to-year earnings decline for the S&P 500 Index. But investors' take on the results has been mostly positive, with both upside and downside surprises eliciting better-than-typical reactions in share prices.

As always, the reaction to results provides the best gauge of whether a company has truly exceeded expectations. That is also true when looking at results for an industry or the broad market, though it can be tough to isolate the impact of earnings when reports flowed in over an extended period.

One sector to watch closely is transportation, a good barometer for the cyclical parts of the U.S. economy. Only six of the 20 members of the Dow Transports have posted June-quarter results so far, with encouraging reports in railroads and mixed results in airlines and trucking. By July 29, 16 of the Dow Transports will have released results.

Based on average Quadrix scores, the four most important groups in the Dow Transports — airfreight (30% of the price-weighted average), railroads (24%), airlines (19%), and trucking (17%) — rank highly for Value but poorly for Earnings Estimates. That suggests some good earnings news could go a long way, as all four groups could rally substantially without hitting the valuation levels reached in late 2014.

Unlike the Dow Industrials and S&P 500 Index, the Dow Transports didn't benefit from the rush into bond-like stocks. Of the three averages, only the Dow Transports suffered a classic cycle of bear market and partial recovery since earnings began to decline.

After reaching an all-time high of 9,217.44 in December 2014, the Dow Transports slumped 28% to their January 2016 low of 6,625.53. The average jumped 22% to reach 8,109.19 on April 20, then suffered a 13% pullback to 7,093.40 on June 27. Now the average has rebounded within 2% of 8,109.19, and a move above that level would represent a fairly classic example of the "higher highs" required for a bull-market confirmation under the Dow Theory.

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