The Transportation Sector Is On Fire

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Includes: CP, CSX, NSC
by: Clif Droke

Summary

Overlooked transportation sector is in excellent shape this summer.

By at least one measure, it has recovered to its pre-Recession level.

Transport stocks are leading the way higher for Dow Industrials.

With the attention of most traders focused mainly on the FAANGs, the leading transportation stocks have slipped quietly under Wall Street’s radar. You wouldn’t know it from listening to the financial press, but the transports are showing remarkable strength and are leading the way higher for the Dow Jones Industrials. As we’ll discuss in today’s comments, the strong performance of the transportation sector is a bullish sign for the stock market as well as for the U.S. economy.

August has so far been a sluggish month for most sectors and for the broad market in particular. While there has been an overall encouraging backdrop thanks to mostly positive earnings, the major indices haven’t made much progress in the last two weeks. Although this is par for the course in August, which historically tends to see low trading volume and diminished participation, it has caused many investors to overlook a particular bright spot on the market horizon. That bright spot is none other than the widely ignored, and often downplayed, transportation sector.

Let’s examine the benchmark index for this sector. The Dow Jones Transportation Average (DJTA) has outperformed most major averages by making a higher peak in August. This is encouraging from a classic Dow Theory perspective, which states that the Transports should either lead or confirm the Industrials in a bull market. The following chart illustrates the leadership of the DJTA relative to the Dow Jones Industrial Average (DJIA) as of Aug. 8.

Dow Jones Transportation Average

Source: BigCharts

The leadership of the transportation stocks tells us at minimum that the U.S. economy is strong and vibrant. Moreover, it tells us that the bull market in equities is alive and kicking this summer and shows no sign of abating anytime soon. Indeed, the well-established uptrend in the DJTA carries a positive implication both for the stock market and for the economy, for it suggests that business is strong and goods are flowing through the various channels of distribution at an accelerating rate. To confirm this, let’s drill down and take a closer look at the various segments of the transportation sector.

Let’s first examine the railroad industry. Rail freight volumes can provide important insights into the intermediate-term strength of the domestic economy. North American rail traffic has trended steadily higher this summer, with most of the car loadings accounted for by petroleum products, motor vehicles and parts, and grain. According to the Association of American Railroads, U.S. rail traffic for July was 5.2 percent higher compared to a year ago. Fifteen of the 20 carload commodity categories tracked by AAR were higher in July 2018 compared with last year’s July. AAR also noted in its latest report that total combined U.S. traffic during the first 30 weeks of this year was 3.9 percent higher than the comparable period in 2017.

Reflecting the rising rail volumes of the past year is the following graph which shows the Dow Jones U.S. Railroads Index (DJUSRR). This index tracks the progression of the top seven publicly traded U.S. railroad companies. As DJUSRR testifies, much of the strength in the overall transportation sector is due to the growth in the railroad business. Historically, rising rail freight volumes have been an excellent coincident indicator of the strength of the U.S. economy.

Dow Jones U.S. Railroads Index

Source: BigCharts

Not only rail, but also trucking shipment volumes have been quite bullish this year. Indeed, 2018 is on track to seeing the highest level for overall freight volumes in over 10 years, according to the Cass Freight Index. The Cass Freight Index for Shipments is an index of North American freight volumes and expenditures covering all forms of transportation. It recently hit its highest level since 2007 and has been trending higher since the start of 2017.

Source: Cass Information Systems

The Cass Truckload Linehaul Index for June (the latest month for which data is available) showed continued acceleration of a rising trend that began in 2017. This index posted a 9.5% year-over-year increase to 134.7 for June, the largest yearly percentage increase of the truckload index since 2005.

Cass Truckload Linehaul Index

Source: Cass Information Systems

With freight demand exceeding capacity in most forms of transportation by a conspicuous margin, the prospect for continued strength in the U.S. economy is quite favorable. Transportation is widely regarded as one of the most important leading barometers for economic strength, and the major forms of transport are now showing levels of improvement not seen since before the Great Recession. This should serve as a warning to the bears that their pessimism on the U.S. economy and equity market isn’t justified and is decidedly premature.

Another way of isolating the strength of the transportation sector stocks - and of railroad stocks in particular - is to compare the performance of the railroad stocks in the aggregate with the Dow Transports. Shown here is a comparison of the Dow Jones U.S. Railroads Index (DJUSRR) with the Dow Jones Transportation Average. This chart underscores the relative price strength which the leading railroad stocks are exhibiting versus the transportation sector, as well as against the broad equity market. Investors should accordingly have bullish exposure to the railroad stocks this summer, including Norfolk Southern Corp. (NSC), Canadian Pacific (CP), and CSX Corp. (CSX) - all of which have excellent earnings growth potential and relative price strength versus the transportation sector and the S&P 500 Index (SPX).

Dow Jones U.S. Railroads Index vs. Dow Jones Transportation Average

Source: StockCharts

On a strategic note, investors should continue to maintain intermediate-to-longer-term bullish exposure to the stock market via ETFs and outperforming individual stocks in strong sectors. This includes in particular the retail, transportation, and real estate sectors, as well as the tech sector (notwithstanding the recent choppiness of the Nasdaq). I also recommend raising of stop losses on existing long positions among the actively traded tech and Internet names, as well as taking profits in stocks and ETFs which have already had impressive upside moves.

Disclosure: I am/we are long XLK, 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.