XTN: Small-Cap Transportation Stocks Have Likely Run Out Of Road

Mar. 18, 2022 5:14 PM ETSPDR S&P Transportation ETF (XTN)ALK, CAR, CHRW, CSX, DAL, EGLE, GNK, HA, HUBG, IYT, JBHT, JBLU, KEX, LUV, MATX, R, SAVE, SNDR, UNP, UPS, XPO
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John Overstreet
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Summary

  • The rising probability of both cyclical and "secular" bear markets over the remainder of the decade is decidedly negative for small-cap transportation stocks.
  • Most small-cap transportation returns occur because they are small caps.
  • The return of the size effect in the second half of the decade will likely lead to long-term small-cap transportation outperformance.
  • Cyclical risks could offset any upside long-term potential.
  • History suggests it is best to wait for a broad-based market sell-off before loading up on XTN.

Freight ship in the harbor

narvikk/E+ via Getty Images

The SPDR Transportation ETF (NYSEARCA:XTN) is an equal-weighted index of all of the stocks in the S&P Total Market Index that fall within the following subindustries: Air Freight & Logistics, Airlines, Airport Services, Highways & Rail Tracks, Marine, Marine Ports & Services, Railroads, and Trucking. In this article, I am going to explain why (a) transportation stocks have a modest chance of outperforming the broader market over the remainder of the decade, but (b) will likely see very low returns nonetheless, and (c) are at risk of a sharp cyclical downturn over the next one to three years.

The ETF is composed of 50 stocks with holdings at present ranging from 3.1% for the top holding to 0.7% at the bottom and 2% on average. Unlike large-cap sectoral ETFs, there tends to be a lot of jostling for position within the index from month to month. In order to anticipate how a herd of cats like this will behave over the long- and short-term, I prefer to see how that herd of cats has behaved in the past.

To do that, I sorted XTN's holdings by SIC code (you can find those on the SEC's website) and then cross-checked those SIC codes with the Fama-French database, which creates industry- and sector-level indexes based on SIC codes that usually go back to 1926.

Below is a table with the top 20 holdings and the respective companies' GICS subindustry and their Fama-French 49-industry classification.

XTN: SPDR® S&P® Transportation ETF holdings as of 16-Mar-2022

Name

Ticker

Weight

Cumulative

GICS Sector

FF49

Matson Inc.

MATX

3.1

3.1

1

Marine

Transportation

Eagle Bulk Shipping Inc

EGLE

2.8

5.9

2

Marine

Transportation

Genco Shipping & Trading Ltd

GNK

2.8

8.7

3

Marine

Transportation

Kirby Corporation

KEX

2.7

11.4

4

Marine

Transportation

Avis Budget Group Inc.

CAR

2.6

14.0

5

Trucking

Personal Services

J.B. Hunt Transport Services Inc.

JBHT

2.5

16.4

6

Trucking

Transportation

Union Pacific Corporation

UNP

2.4

18.8

7

Railroads

Transportation

Alaska Air Group Inc.

ALK

2.4

21.2

8

Airlines

Transportation

United Parcel Service Inc. Class B

UPS

2.4

23.6

9

Air Freight & Logistics

Transportation

Schneider National Inc. Class B

SNDR

2.3

25.9

10

Trucking

Transportation

Southwest Airlines Co.

LUV

2.3

28.2

11

Airlines

Transportation

JetBlue Airways Corporation

JBLU

2.3

30.5

12

Airlines

Transportation

Ryder System Inc.

R

2.3

32.8

13

Trucking

Personal Services

XPO Logistics Inc.

XPO

2.2

35.1

14

Trucking

Transportation

Hub Group Inc. Class A

HUBG

2.2

37.3

15

Air Freight & Logistics

Transportation

C.H. Robinson Worldwide Inc.

CHRW

2.2

39.5

16

Air Freight & Logistics

Transportation

Hawaiian Holdings Inc.

HA

2.2

41.7

17

Airlines

Transportation

Spirit Airlines Inc.

SAVE

2.2

43.9

18

Airlines

Transportation

CSX Corporation

CSX

2.2

46.1

19

Railroads

Transportation

Delta Air Lines Inc.

DAL

2.2

48.2

20

Airlines

Transportation

The vast majority of these stocks are classified as Transportation. Indeed, by my count, 85% of the ETF's holdings are Transportation, 13% Services, and the remaining fraction in Aircraft and Software.

The GICS classifications are more granular, and you can see subindustry weightings in the following chart from State Street Global Advisors (linked to in the first paragraph). Most of the XTN holdings that are classified as Business Services or Personal Services by Fama-French come out of the Trucking subindustry (roughly a third). Even though Shipping companies currently make up the top four holdings of the ETF at present, the subindustry as a whole only makes up about a tenth of this transportation index.

XTN subindustry allocations

Chart A. The index is split evenly between surface and air transport. (State Street Global Advisors)

In any case, we are going to begin with an overview of the historical performance of equal-weighted Transportation stocks and see if that suggests any clues about possible future performance.

Long-term performance of transportation stocks

The following chart shows the performance of cap-weighted and equal-weighted transportation stocks relative to the S&P Composite since 1926 (data from Robert Shiller).

large-cap and small-cap transportation indexes relative to S&P 500 total returns

Chart B. Small-cap Transportation stocks have held up well against the S&P 500 for the most part. (Fama-French, Shiller)

Since the Depression, there has been a wide divergence in the relative performances of the large- and small-cap Transportation indexes, but over shorter durations, their relative performances have tended to correlate.

Relative to Treasury bonds (data from St. Louis Fed and Shiller), they have outperformed since the Depression, but their relative rates of growth have diminished since the late 1960s.

Transportation stock total returns relative to Treasury bonds

Chart C. Long-term momentum in Transportation stocks declined after the 1960s. (Fama-French, Shiller, St. Louis Fed)

A key metric for studying stocks, in my opinion, is how they behave under conditions of commodity inflation and deflation or when the broader market is in a "secular" bull or bear market.

Small-cap transportation stocks are first and foremost small caps

Depending on how you read Charts B and C above, the heyday for small-cap Transportation stocks ended either around 1968 or 1983.

The problem with small-caps is that they follow rules that are somewhat different from large caps. Large caps, for example, do not like commodity inflation, but the chart below suggests that Transportation small caps do best when there is long-term reflation in commodities and the broader equity market. They do not seem to do especially well in periods of peak commodity inflation (e.g., the late 1940s, the early 1970s, the late 1970s, the late 2000s and early 2010s) or periods of declining momentum in the S&P Composite, but it is quite difficult to come up with simple rules of thumb for Transportation small caps.

long-term changes in S&P 500, commodities, and small-cap Transportation stocks

Chart D. Small-cap Transportation stocks do not mimic benchmark large-cap patterns. (Fama-French, Shiller, St. Louis Fed, World Bank, Warren & Pearson)

Sources for how I compiled this Historical Commodity Index can be found in How And Why I Am Breaking My Rules For Commodity Trading.

In my most recent overview of the size effect over the last century, I found that almost all periods of major small-cap outperformance occurred during "secular" bear markets in large-cap equities, as can be seen in the following chart.

the size effect in equities versus the absolute performance of large-caps

Chart E. The size effect is most powerful during secular bear markets. (Shiller, Fama-French)

The following chart shows the long-term total returns performances of small-cap Transportation stocks (in blue) and an average of small-cap sectors (in orange) relative to the S&P Composite.

size effect in transportation stocks and broad market

Chart F. The size effect seems to determine the majority of small-cap Transportation returns. (Fama-French, Shiller)

Small-cap transportation stocks are highly correlated with the expression of the size effect in the market as a whole. But, it has to be noted that during the Depression, small-cap Transportation stocks had trouble keeping up with the broader market.

Since my models point to Depression-like outcomes in the 2020s to be led by a sharp cyclical downturn over the next two to three years, these small-cap Transportation stocks may be less likely than other small-caps to outperform this decade, which in turn suggests it would not be prudent to take a long-term position in Transportation small caps until after a considerable absolute market-wide decline.

The following chart shows that every major stock market decline over the last century except one (the crash in the early 2000s) has seen extreme cyclical underperformance of small-cap Transportation stocks.

cycles in small-cap transportation total returns and S&P 500 total returns

Chart G. Cyclical bear markets are usually worse in small-cap Transportation stocks. (Fama-French, Shiller)

So, all of the worst sell-offs occurred during "secular" bear markets in the benchmark indexes like the S&P 500. Yet, the "secular" bear markets were periods of long-term outperformance by small caps, including small-cap Transportation stocks. By extension, the best time to buy small-cap Transportation stocks is at the cyclical bottom of a "secular" bear market. The only occasion where that would have led to a missed opportunity is the small-cap boom of the 1960s, which seems to have somewhat anticipated the bear market, but those conditions do not seem to be present now.

Valuations in small-cap transports do not appear to be predictive

I do not have long-term data on Transportation stock earnings, so I cannot determine what historical PE ratios were, but dividend yields are often a close approximation, if one keeps in mind that dividend growth has tended to be lower than earnings growth since the 1950s.

I calculated the historical dividend yield for small-cap Transportation stocks by contrasting total returns and price returns.

small-cap transportation dividend yields and price returns

Chart H. The dividend yield does not appear to be especially predictive of returns. (Fama-French)

Perhaps the rise in the dividend yield points to higher returns, but there is only a very weak correlation between the two (0.25 between the yield and total returns).

There is a slightly higher correlation between the dividend yield and the subsequent performance of the dividend side of the fraction.

small-cap transportation dividend yield and subsequent dividend growth

Chart I. The dividend yield has had a slight ability to anticipate dividend growth (Fama-French)

High yields point somewhat to the slightly increased possibility of low to negative dividend growth.

In the Seeking Alpha chart below showing XTN's dividend yield relative to the S&P 500's, we can see the curious rise in small-cap dividend yields since 2007.

dividend yields for XTN and SPY

Chart J. The gap between dividend yields has been closing in recent decades. (Seeking Alpha)

If we contrast price returns and dividend growth, as in the following chart, we can see that the rise in the yield is due to a secular decline in the growth rate of prices and a secular rise in the rate of dividend growth. Historically, there has been something of a correlation between price performance and dividend growth, but it has diminished since the 1970s.

long-term dividend growth and price performance

Chart K. Dividend growth and price returns used to be positively correlated. (Fama-French)

The change in the relationship between dividends and price over the last 15 years is much less apparent in Transportation large caps, so it is difficult to say where this change is coming from or what it means.

small-cap and large-cap dividend yields for Transportation stocks

Chart L. Small-cap dividend yields exceeded large-cap dividend yields for the first time ever. (Fama-French)

The recent rise of small-cap dividend yields appears to be unprecedented. This is the first time it seems to have exceeded large-cap yields (as seen in the chart of the cap-weighted transportation index (IYT) below).

dividend yields for IYT and XTN

Chart M. The pandemic probably boosted small-cap yields. (Seeking Alpha)

That leads me to suspect that this is primarily being driven by the pandemic and its aftershocks and may not be meaningful. But, it does seem that this gap was already being narrowed well before the pandemic.

It's the macro that matters

Ultimately, I can find no consistent relationship involving small-cap Transportation stocks and their dividend yield. Rather, the macro relationships involving broader large-cap and small-cap patterns seem to be more salient.

Historically, seven-year outperformance by tech stocks relative to the other sectors, especially when paired with marked energy underperformance, has been followed both by the exact reverse pattern (that is, energy outperformance and tech underperformance) over the next seven years. Moreover, this has historically been paired with low returns - i.e., "secular" bear markets - in the benchmark indexes over the same period. And, "secular" bear markets are highly cyclical: equities behave as if they were commodities and cyclical stocks (like energy) outperform. We can layer on top of that outperformance of small caps, but we must remember that small caps are also highly cyclical. That means that the best way to gain exposure to the size effect is to wait until the cycle has bottomed.

Lately, I have been working on a separate and more complex and dynamic system of indicators for small caps that appears to be predictive of subsequent relative performance in that space. I am not prepared to present that quite yet, but that system suggests that the size effect may not be ready to kick in until 2024, which roughly confirms my other research linked to above pointing to a strong cyclical bear market until about that time.

Conclusion

At present, XTN's technicals do not appear especially weak. It is currently smack in the middle of its 52-week range, but this is nonetheless a serious reduction in cyclical momentum.

52-week performance of XTN

Chart N. 52-week and rangebound likely spells declining momentum. (Stockcharts.com)

I do not know what the short-term fate of these stocks will be - nor do I know their long-term fate - but it appears to me that, because of macro-market conditions, the preponderance of long-term risk (until the end of the decade) for the XTN is to the downside, and especially over the course of the next one to three years. Once that cyclical storm is past, perhaps after the ETF clears its 2020 lows (roughly half of its current value), there may be considerable risk of outperformance in these small caps.

This article was written by

John Overstreet profile picture
1.75K Followers
I study markets from a long-term historical view, especially the interaction between yields and inflation across all major asset classes. I have a bachelor's degree in political science, history, and intelligence analysis, and a master's in political theory. My Seeking Alpha articles have been mentioned in Marketwatch and Real Clear Markets. I have lived in Asia for twenty years.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

Additional disclosure: I am long SSG, QID, CMDY.

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