Transports Week In Review - Even If Economic Growth Remains Subdued, Transports Are Poised To Outperform Broader Indices

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Includes: AAWW, ALK, ATSG, CSX, CVTI, DPSGY, DSKE, ECHO, ELD, EWC, EWW, FCNTX, FDX, GBX, GSL, HUBG, KSU, LTL, LUV, MATX, MSC-OLD, NSC, RAIL, RLGT, SPY, STB, ULH, UPS, USAK, VFINX, VTI, WAB, XPO, XTN
by: James Sands

Summary

The XTN transports index is now up 0.8 percent; whereas the SPY is up 9.4 percent.

It is looking more likely that macroeconomic growth will be closer to 2-2.5 percent GDP for 2017.

Despite these expectations, transports are positioned to outperform broader indices.

Performance for transports near or below the 1 percent level is a key area for investors to monitor for stronger growth potential.

Source: Google Images

As we closed the week on August 25th, transports have recovered back to positive territory. Oil prices remain weak, and rather than an acceleration for economic growth, a more likely scenario is continued growth near 2 percent.

Earlier in the year, I was hopeful for accelerated growth. This was not based upon catalysts driven by policy changes from the Trump administration, but rather on increasing consumer demand and domestic improvement in the U.S.

Rather than expecting stronger economic improvement, the focus should remain on transports closing the gap from broader indices. If the U.S. can come to agreement on major policies including healthcare, tax reform and trade deals, catalysts increasing growth could still occur. With a recession/contraction not being discernible over the next 18 months, transports may be poised for stronger performance over this period.

I manage the Lean Long-Term Growth Portfolio (LLGP). To date, performance stood at 7.6 percent, as highlighted in green. Transports remain volatile, but still are far above May’s lows. The anomaly remains the Nasdaq Transportation (^TRAN) index, now up 8.3 percent. Both the Nasdaq (^IXIC) and Fidelity Contrafund (FCNTX) remain strong, up 16.4 and 19.8 percent.

The Dow Jones (DJT), SPDR S&P 500 ETF (SPY), Vanguard 500 Index (VFINX) and Vanguard Total Stock Market ETF (VTI) were all up 8.7 to 10.4 percent. Mid- and small-cap indices continue to lag larger capitalization and broader diversified peers. Transports, for the most part, continue to underperform all.

YTD 2017 SPY Vs. XTN Index Prices

For the 33rd week of 2017, the spread between the SPY and the S&P Transportation ETF (XTN) was flat with the SPY up by 8.6 percentage points. The SPY increased by 80 basis points (bps) to 8.6 percent, while the S&P Transportation ETF also improved by 80 bps to zero percent for 2017.

Transports remain volatile, despite improving demand trends. Leading segments for North America continue to be railroads, air cargo and shipping container liners, while the trucking industry has picked up, and asset-light providers are set up to benefit lagging all other peers.

Rail Operators

Rail operator performance was mostly positive for the week with exceptions being Norfolk Southern (NSC) and Kansas City Southern (KSU). CSX (CSX) has been the story of late, as the company has been asked by the Surface Transportation Board (STB) to provide more information regarding its service issues. Many large customers have expressed strong concerns regarding service issues, and a lack of support to alleviate impacts. CSX recently has adjusted its performance metrics, which now are not consistent with other Class I peers – Hunter Harrison’s honeymoon is over.

Week 33 of 2017 witnessed increased results for most Class I's based on total traffic carried. The rate of improvement increased from the previous week – expectations should be tempered as the rest of the year will face a higher comparable baseline. The most recent monthly Class I rail traffic report can be found here.

Railcar Manufacturers & Lessors

Railcar manufacturers and lessors were mixed for the week with The Greenbrier Companies (GBX), FreightCar America (RAIL) and Westinghouse Air Brake Technologies (WAB) all down. Volatility remains an uncertainty as substantial stock price gyrations have been prevalent for most of the year. This type of pattern is likely to continue.

There are a couple of challenges facing railcar manufacturers today. First, is the uncertainty mentioned above. Second, rail operators clearly are also not witnessing substantial increases in railcar demand as expressed through capital expenditure programs. We may be approaching a railcar backlog bottom, so investors should continue to monitor orders.

Truckload Carriers

Truckload carriers were up during the week with the only exception being Daseke (DSKE). Daseke continues to lead all peers for the year, by stock performance. Some smaller peers including USA Truck (USAK), Covenant Transportation (CVTI) and Universal Logistics Holdings (ULH) have witnessed strong improvement of late. Larger peers continue to outperform smaller peers on average.

Ever since the April/May lows, the trucking industry has held up pretty well of late. There is still opportunity for greater stock price appreciation from today’s levels based upon tightening demand in the near term.

Less-Than-Truckload Carriers

Less-than-truckload [LTL] carriers were flat to modestly higher, lagging their truckload peer performance for the week. Truckload peers are poised to continue to outperform LTL peers resulting from their greater depressed stock price state earlier in the year.

Seasonal rates since late March have remained fairly robust for LTL carriers. Through the first half of 2017, pricing yields have remained disciplined and shipment volumes have been on the rise. Like truckload peers, LTL carriers are poised to see improving stock price performance.

Air Freight, Package & Delivery

Air freight, package and delivery companies were up for the week with the exception being Air Transport Services Group (ATSG) for the second consecutive week. Air Transport has witnessed weakness since its latest earnings report. Deutsche Post DHL Group (OTCPK:DPSGY) and Atlas Air Worldwide (AAWW) have closed the gap and may compete for the top performer for 2017.

FedEx Corporation (FDX) could also have been competing but the TNT Express uncertainties have reduced performance. United Parcel Service (UPS) has been fairly stable, despite being the laggard for the year.

Contract Logistics, Forwarding & Brokerage

Contract logistics companies were mostly positive for the week with exceptions being Echo Global Logistics (ECHO) and Radiant Logistics (RLGT). Anticipation continues to revolve around the next acquisition by XPO Logistics (XPO). But it may be a little bit before any offer is put on the table. Hub Group (HUBG) has remained highly volatile since weakening margins have surfaced. This has presented buying opportunities as margins should see a return to improvement in the near term.

I continue to expect logistics peers to offer upside during the back-half of 2017. As the trucking industry continues to see increasing freight rates, this should lead to improving margins for asset-light businesses. We should get better visibility over the next couple of quarters.

Container Shipping Lines, Charter Owners & Container Lessors

For the container shipping industry, weekly performance was positive with the exception being Global Ship Lease (GSL). Matson (MATX) continues to be a focal point as the recent news surrounding a third competitor entering the Hawaii market is not conclusive. Upside potential could materialize, but timing is not clear due to speculation.

For the shipping line container industry, the important focus remains on spot market freight activity. Last year’s lows have provided for strong improvement for profits during the first half of 2017. Moving forward, it will be important for disciplined pricing; some global liners are looking at adding new capacity, which could thwart this stability.

Airlines

Airline stock performance for the week was negative which is all too typical despite a one-day rally during the week. Every airline stock in the chart above remains negative with the only exception being Southwest Airlines (LUV), which is now up below 6 percent. Profit taking is an understatement; increasing pricing competition and labor costs are primary concerns.

In addition to margin contraction concerns, recent terrorism and continued volatility with North Korea have weighed on the recent negativity surrounding airlines. My pick for the long term remains Alaska Air Group (ALK), which has been punished lately – I continue to average as new lows are set.

Demand Trends

Key demand-based indicators that are monitored include Class I rail traffic, trucking industry tonnage, shipments, and loads, air cargo tonnage, container shipping line twenty-foot equivalent units, TEUs, North America seaport TEUs, shipping lane port calls, North America cross-border trade, and freight rates for most of these indicators.

U.S. & Canada Class I Rail Traffic – Carloads & Intermodal Units Carried

Through the 33rd week of 2017, total traffic remained up 5.1 percent with carload traffic up 5.5 percent, down 10 bps, and intermodal traffic up 4.6 percent, up 10 bps. Week 33 performance remained solid, witnessing accelerated performance from the previous week.

These numbers continue to not be far off from the total traffic originated results of 5.4 percent for the first 33 weeks of 2017 for North America rail traffic, published by the Association of American Railroads (NYSE:AAR) data. Investors should remember that total traffic carried includes both originated and received carloads and intermodal units. Additionally, U.S. traffic was up 4.2 percent and Canadian traffic was up 11.5 percent, closely tracking the carried rail traffic when combined. Mexico traffic was flat, as improvement has been sustained.

Container traffic was up 4.6 percent, up 10 bps. Domestic intermodal pricing for both eastbound and westbound averages have improved being up close to 10 percent versus last year. Fuel surcharges have been a big part of improved pricing; core pricing has been up modestly.

Week 33 witnessed weekly coal carload traffic at 122,000 carloads carried. This reflected a 5.7 percent increase versus last year. Week 33 reflected the third consecutive positive week as growth accelerated. Grain performance was down, at -19 percent versus last year. Similar to coal, weekly growth from this point forward will be choppier; this was the seventh consecutive week of negative performance.

Motor vehicles and equipment carload traffic performance was down -5 percent versus last year - the sixth consecutive drop from previous performance levels. Chemicals were up 8.7 percent, petroleum products were down at -8.4 percent and crushed stone, gravel and sand remained on a roll, up 24.1 percent.

Trucking Industry

Source: Cass Information Systems, Cass Freight Index

As of mid-August, dry van trucking industry spot rate averages remained robust versus last year’s performance, with results up near 10 percent. Seasonal performance has remained strong led by dry van, temperature-controlled, heavy haul and specialized. Flatbed and LTL performance has been solid.

Diesel prices have returned to double-digit performance from last year for three consecutive weeks now. This follows 11 consecutive weeks of only single-digit growth previously. Expectations for improved demand, pricing, with sustained fuel costs allow for near-term tailwinds towards an improving trucking industry environment. Additionally, the electronic logging device [ELD] mandate will be pushed to April of next year for those not complying.

Air Cargo

We know that air cargo carriers and freight forwarders have been some of the stronger performers during 2017. This performance is anticipated to continue, but growth is expected to moderate at some point in the near term. The three behemoths, FedEx, United Parcel Service and DHL Group have benefited strongly through June 2017.

There could be an increase for air freight from the recent flood damage in Texas; while hurricane weather wreaked havoc on flights, the aftermath of issues for surface transportation should lead to air cargo increases. Investors should be focused on the sustainability of demand and pricing over the near term.

Container Shipping Lines

Source: Alphaliner – Top 100 Operated Fleets

Pricing for spot market container rates have remained in a downtrend since the peak in mid-January, per the Shanghai Containerized Freight Index (SCFI). However, since late-July, rates have improved strongly through mid-August.

Year-over-year (YoY), the Shanghai to West Coast average spot rate was up over 30 percent; to the East Coast, average spot rates were up greater than 40 percent. Asia to Europe average spot rates were up greater than 30 percent. The trans-Atlantic trade also remained mixed, with outbound to Europe up double digits.

The most important focus for global container shipping lines is the threat of renewed capacity growth. CMA CGM has signed a letter of intent for an order of nine new 22,000 TEU ships. New reports have surfaced regarding Mediterranean Shipping Company [MSC] planning to order 11 ships at 22,000 TEUs apiece. If capacity growth heats up again, pricing could suffer.

North America Seaports

Expectations for July’s top North America seaport TEU performance are for robust results. Initial seaport numbers have been strong. The total business inventories to sales ratio has not dropped as some have expected, but it has not risen to all-time 2016 highs either. Macroeconomic trends have not provided perfectly clear indicators, but it appears that peak-season shipping will be strong.

On the positive side, the seaports of Los Angeles and Long Beach have reported lower emissions despite increasing volume growth in 2017. As for the Jones Act, container vessels on the West Coast serving California will need to be compliant by 2020 through the use of hybrid diesel-LNG engines.

North America Cross-Border Trade

The iShares MSCI Mexico Capped (EWW) was up by 170 bps for the week. The index continues to outperform the iShares MSCI Canada ETF (EWC). The Mexico index is now up 31 percent for the year versus the 6 percent result for the Canadian index - which was also a 170-bps increase.

Now that the North America Free Trade Agreement (NAFTA) renegotiation talks have begun, the focus has shifted on whether consensus can be achieved. My inclination is to expect these negotiations to be drawn out as the Trump administration will likely continue to push for more aggressive outcomes. However, tangible results will probably lead to less extreme changes.

Summary

Market volatility, while seemingly lower than some recent past economic cycles, is very much a real factor for the near term. Markets remain in a bull cycle, and as a result, despite the geopolitical uncertainties, they continue to return to their long-standing positive trend.

Transport fundamentals continue to sustain strong performance and/or push higher. Investors should remember that these trends are lagging indicators, so they are not an indication of how the future should play out. Nonetheless, positive performance continues, yet transports continue to experience greater volatility.

Disclosure: I am/we are long DPSGY, FDX, MATX, XPO, KSU, GBX, ALK, HUBG.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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