After a several long, frustrating weeks of going nowhere the transportation sector is finally moving forward. Held back by the under-performing airline stocks, the Dow Jones Transportation Average (DJTA) was confined to a narrow lateral range for the better part of the last four months. The DJTA has finally broken free from the confines of its multi-month holding pattern, however. In today’s commentary I’ll explain why this bodes well for the interim outlook and why the Dow Industrials will soon follow the Transports higher.
This week’s decisive breakout in the Dow Transports serves as a clarion call to the bulls. From a Dow Theory perspective, it shows that the bull market is still very much intact and has regained its health and vigor after suffering through four months of indigestion. The breakout strongly suggests moreover that the lateral range in both the Dow Transport and the Industrial averages since February was clearly a bullish consolidation pattern. This means that informed investors and institutions didn’t use the four-month trading range to mask distribution (selling) activity. Rather, they used it to consolidate their positions - trimming lagging stocks in their portfolios while increasing their stakes in winning positions and even adding new positions among attractively valued stocks.
Shown here is a chart comparing the Dow Transports (DJTA) with the Dow Industrials (DJIA). As discussed in a recent commentary, the DJTA has been leading the Dow Industrials on the upside recently. Now the relative strength for the Transports has increased as the DJTA powers ahead. Historically, leadership in the Transports in a market characterized by strong fundamentals and health liquidity levels (like the present one) has resulted in the Industrials catching up with the Transports. This is the basis of the Dow Theory which was systematized by William Peter Hamilton and Robert Rhea. The Dow Theory is arguably the most venerable of all technically-based market theories and has proven its worth countless times over the past century. This time should be no exception. With the Transports beginning to accelerate higher it should be only a matter of time before the Industrials follow suit.
Ironically, one of the driving forces behind the strong performance of the Transports, and indeed of other sectors, has been the recent turmoil in Europe. Investors in Europe have been worried over the instability of Italy’s political system. While this initially resulted in a flight to safety which saw a temporary spike in U.S. Treasury bond prices (and a drop in yields), the main impact has been to U.S. equity prices. The latest jolt to euro zone confidence has caused overseas investors to closely evaluate the economic prospects of the U.S. They’re coming to realize that the U.S. economy is rapidly gaining forward momentum. Consequently, the U.S. equity market offers a far greater investment potential to foreign investors than their own markets. U.S. stocks which stand to benefit the most from an improving economy, namely companies which transport goods, are therefore the prime beneficiaries of “hot money” inflows. Thus the Transports are among the stocks seeing the immediate benefits of this global flight to quality.
Among the individual transportation sector stocks which are showing the greatest signs of investment demand right now are railroad industry stocks. Shown below is a graph comparing the Dow Jones U.S. Railroad Index (DJUSRR) with the Dow Jones Transportation Average. This illustrates the relative strength of the railroad stocks right now.
Among individual stocks in the railroad industry, CSX Corp. (CSX), Norfolk Southern Corp. (NSC), Union Pacific Corp. (UNP), and Wabtec (WAB), all of which continue to make regular appearances on the new 52-week highs list. In particular, CSX sports excellent relative price strength versus the industry group as illustrated in the following chart comparing its stock price with that of the Dow Railroad Index. As an industry, the railroad stocks also sport attractive price/earnings multiples and have excellent earnings growth potential in an expanding economy like this one. The combined technical picture of these stocks is also promising and many of them can be considered as true momentum stocks.
Aside from the strong performance of the transportation sector, one of the most promising aspects of the current broad market environment is that with the summer season approaching, we can likely expect the market to have an easier time of moving higher. This is in part because of the tendency of trading volumes to diminish during the summer. While some participants consider this to be a potential downside risk, it can actually increase upside potential since the market can make greater headway in a low-volume environment where there aren’t as many conflicting factors it must deal with. Indeed, in recent years we’ve seen more than a few low-volume summer rallies take place which were productive for the overall growth of the bull market. I suspect this summer will prove to be no exception to that norm and we’ll likely see the Dow Industrials making a new high with the Transports leading the way.
The most important confirming factor for the market’s bullish condition, short-term, continues to be the constructive appearance of the new 52-week highs and lows on both exchanges. The NYSE new highs-new lows ratio has been quite healthy lately with a 4:1 or even a 5:1 high/low ratio commonly seen. Meanwhile the Nasdaq-listed stocks continue to outperform with 6:1 and even 7:1 high/low ratios being seen in recent days. This confirms that incremental demand for equities remains quite strong and that the bulls are still in control of the short-term trend. It’s also worth mentioning that the number of stocks making new 52-week lows on both exchanges has been below 40 recently, which is a sign of a normal, healthy market condition.
For now I continue to recommend that active investors maintain a bullish stance. Selective purchases among the stocks showing definite signs of relative strength are warranted, including leading tech sector and transportation sector stocks. In particular, investors should focus their attention among internet and railroad stocks as discussed in recent reports.
Disclosure: I am/we are long XLK, HACK, IYR.
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.