Transports' Divergence A Worry


Solid earnings reports have pushed the Dow Industrials to all-time highs in recent trading, but the Dow Transports have slumped on disappointing air-freight, airline, and railroad results.

While the divergence between the two averages heightens the risk of a near-term pullback, the Dow Theory remains in the bullish camp. Our buy lists have 94.8% in stocks, with the remainder in a short-term bond fund.

Extreme divergence

In early July, when the Transports finally confirmed the Industrials by reaching new highs, we warned that “it is not unusual for the broad market to pull back following a fresh confirmation.”

What is unusual is the extreme divergence between the two averages since the confirmed new highs. Since the Industrials and Transports both closed at all-time highs on July 14, the Transports have moved lower in 10 of 13 trading sessions.

The Transports have slumped about 600 points, or 6%, since July 14, retracing nearly two-thirds of their advance from the low reached in May. Meanwhile, the Industrials have gained nearly 2%, closing above 22,000 for the first time.

Has anything really changed, or is the divergence since July 14 just statistical noise? That is a tough question to answer in real time, but there’s no doubt that sentiment toward transportation shares has dimmed.

• Airline stocks slumped on disappointing forecasts for third-quarter unit revenue, along with signs of slightly faster-than-expected capacity growth.

• All the major U.S. railroad stocks have dropped since posting second-quarter results, even though they mostly reported better-than-consensus earnings.

• Similarly, FedEx ($210; FDX) and United Parcel Service ($111; UPS) fell after UPS beat on earnings and sales but failed to lift its full-year guidance.

Historically, the economically sensitive Transports have often served as a canary in the coal mine, warning investors of a deteriorating outlook for the economy and corporate profits. At the same time, the Transports are inherently volatile stocks, and to see them pull back on earnings news after a big run is not surprising.

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