The stock market’s recent surge to new all-time highs may be nothing more than the silver lining in a very dark cloud: Weakness in the transportation sector.
Many advisers consider that weakness to be ominous, on the theory that the sector is a leading economic indicator. If so, then the sector is warning us of imminent economic trouble.
Consider the Dow Jones Transportation Average, one of the lesser-known Dow Jones indexes that consists of a basket of stocks from the airline, trucking, railroad and shipping industries with stocks such as Delta Air Lines, FedEx, Norfolk Southern and Ryder System. Even as the better-known Dow Industrials were recently hitting another high, the Dow Transports were trading 15% below their all-time high set in December 2014.
Over the same period, the broad stock market — as measured by the S&P 500 index — gained 4.4%. Such a wide divergence is rare — and significant.
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It certainly seems plausible that the transportation sector would be a leading indicator of the economy as a whole. The Committee on National Statistics of the National Research Council explained why in a 2002 book entitled Key Transportation Indicators: Not only are transportation industries “major economic activities in themselves,” the committee wrote, transportation also “is a cost, to a greater or lesser extent, of virtually every other good or service in the economy.”.
This theory was confirmed statistically by the U.S. Department of Transportation. In a December 2014 study, that Department’s Bureau of Transportation Statistics reported that trend changes of the transportation sector between 1979 and 2013 led trend changes in the economy by an average of approximately four months. The Bureau based its study on the Transportation Services Index, which it calculates itself; that index hit its all-time high in July of last year.
To be sure, the U.S. Economy has not entered a recession, at least as measured by Gross Domestic Product, but other broad measures of economic activity paint a less sanguine picture. Total revenue at publicly-traded corporations reached a peak in 2014 and has been declining ever since. Corporate profits have plunged: Earnings per share of S&P 500 companies over the last 12 months were 18% lower than where they stood two years ago.
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The reason the broad stock market averages have been able to reach all-time highs even as earnings were declining: Investors have been willing to pay more per dollar of earnings than they were before. Two years ago, for example, the S&P 500’s price-to-earnings ratio — based on trailing 12-month as-reported earnings — was below 19. The comparable ratio today is above 25. The average over the last 100 years has been 16.1.
Higher P/E ratios, of course, mean the stock market is that much more vulnerable to any unexpected economic weakness.
Richard Moroney, editor of the Dow Theory Forecasts service, is one adviser who is paying close attention to the transportation sector’s weakness. He notes that the Dow Transportation Average has been unable to surpass its high from this past April, much less its all-time high from late 2014. Until and unless that Average can jump over even that lower hurdle, he argues, investors should brace themselves for a market decline by keeping at least some portion of their equity portfolios in cash or a short-term bond fund.
Mark Hulbert, founder of the Hulbert Financial Digest, has been tracking investment advisers’ performances for four decades. For more information, email him [email protected] go towww.Hulbertratings.Com.