Shipping Stocks Starting to Turn

One of the strongest groups we follow has been the shipping stocks. They have gotten beaten up enough lately that investors are asking themselves: has their run ended?

My colleague here at DGA, Chip Hanlon, who serves as lead advisor on a shipping portfolio for Claymore Securities, refreshed his research with a channel check on current voyager rates and charter demand. These are really the drivers of shipping securities stock prices, as they go hand in hand in determining the asset values of a shipping company's fleet.

Meanwhile, I (the Chart Whisperer, as Chip has taken to calling me lately... embarrassing) have looked from my usual technical vantage point where this group stands, given the volatility we have seen.

First, fundamentally Chip reports a generally firm market, albeit a two-sided one: the dry bulk shippers have been more than impressive as rates have been astonishingly strong all year, providing strong cash flows. Last week's hiccup in the Baltic Dry Index seems to us just a pause in the break neck increases over the past 3 months. For the fuel tanker companies, however, the market is softer. Seasonally, this is the time of year that buyers line up their charters for the North American heating season, which should lead to higher charter rates. With generally warm weather in the U.S., however, charterers are talking a wait-and-see approach, to the frustration of owners.

On the supply side of the market, dry bulk supply remains remarkably tight while tankers are in mild oversupply. While markets are worried that newbuilds could swing the bulkers to over-supply in 2009-2010, this looks like an old story which gets re-hashed periodically. Eventually such markets do even out, but it looks to us like it will take at least 3 years before new supply should dramatically impact dry bulk pricing (a severe global recession could dampen prices in before then). The bullish case countering the new supply coming on line over that time is the scrapping of older, less efficient ships, ever-increasing demand from developing nations for the raw materials they need, the increasing distance of today's new shipping routes and the shortage of modernized global seaport infrastructure to handle the increasing trade.

Technically, many of the stocks in the 60-odd member universe have been consolidating, which shouldn't be terribly surprising given their powerful first-half rallies. But investors often give up too early on sectors in strong up trends. So how does one tell, technically, if a trend has run out of room? Two very important tools I use are trend lines and relative strength. For me they are indispensable in defining my sell strategy and minimizing the frustration of selling a strong stock far too early.

In the bulk shippers, DryShips, Inc. (DRYS) has been hot as a pistol - its 12 month low is $13 and 12 month high in $131. In the chart below you can see its consolidation: reaching a top twice at $130, breaking a meaningful bottom at $120 and then following through with some additional breaks. Notice that DRYS experienced a similar consolidation earlier in the summer (shown here in the lower left hand corner of the graph). What sticks out to me is that the current consolidation is taking place near the medium point on its trading band - labeled "Med' on the graph's right side - just where I expect strong stocks to pause in an extended up-trend. Furthermore, the trend line is way down at the $45 level and the relative strength reading is nowhere near a reversal, although another double-bottom break near $102 would be another small warning sign.

Nordic American Tanker, meanwhile, (NAT) has been in a multi-year trading range which it has occasionally broken out of without any significant follow through (in both directions). I will say this about NAT, investors in it have been able to earn a nice dividend along the way, and at a current 13% it's still worth consideration. Today's move below $34 is technically a negative for NAT, but it has shown trend line violations in the past, only to reverse up and restore its positive trend. Most important to watch as a sign of a true downward reversal: the relative strength is still on a buy signal but is close to a reversal down, perhaps indicative of the softer fundamentals facing tanker stocks today (as opposed to the strength in dry bulkers). That point and figure relative strength reading will be crucial in helping to determine if this is yet another false breakdown, or a downward break investors should take more seriously as sign things have changed for the worse.

I believe this group could very well complete its consolation soon and initiate another leg up, but there's no reason to be married to this assumption; I will be watching to see how technical conditions shape up. More to come soon, I'm sure.

Disclosure: Long DRYS, NAT