A Closer Look At the Transports

I'm a big fan of Dow Theory, which in a nutshell is:

A theory which says the market is in an upward trend if one of its averages (industrial or transportation) advances above a previous important high, it is accompanied or followed by a similar advance in the other.

Basically, more than one average has to advance for the market to be in a rally. This makes basic economic sense. When the economy is expanding, businesses have to ship more and more stuff from point A to point B. The converse is also true; when the economy is slowing, businesses have to ship less and less stuff from point A to point B. That's why the following news items have caused me some concern:

United Parcel Service Inc (NYSE:UPS - News) warned on Monday that second-quarter earnings would be below expectations, blaming high fuel prices and a sluggish U.S. economy.

.....

UPS estimated earnings of 83 cents to 88 cents a share for the quarter, down from a prior view of 97 cents to $1.04 per share.

In a statement, UPS said U.S. package volume had been lower than expected, while demand for higher-priced air delivery services had seen a particular drop.

Keith Schoonmaker, an analyst at Morningstar, said the warning from UPS was hardly a surprise, given the monstrous head winds the industry faces.

"This just shows that in a challenging economic environment, with high fuel prices, that some customers are shifting to slower, cheaper shipping alternatives" within both UPS and its rivals, he said.

And add this to the mix:

FedEx(FDX - Cramer's Take - Stockpickr) says it will miss analysts' estimates for the current quarter and for fiscal 2009, as the continuing impact of high fuel prices and a weak economy drag on.

"We're pressured by serious economic difficulties," said CEO Fred Smith, on an earnings conference call. "Record high fuel prices and the weak U.S. economy dampened volume growth and substantially affected our bottom line."

Smith added that the "economic headwinds" the company is facing this year will continue into fiscal 2009. But he noted that results during this year and next "will be anomalies" that will "hopefully set the stage for fiscal year 2010."

That makes this an opportune time to take a look at the Transportation average.



On the 6-month chart, notice the average has been rallying since the first part of the year. There are two important trend lines. The first is from the extreme bottom in mid-January. While this is technically a place to draw a trend line from, I'm always reluctant to draw a line from a point this extreme on a chart. I think the more accurate line is the second line started just after the extreme point.

Using the first trend line (the one from the extreme point) notice the average broken trend in mid-May. Using the second line, notice prices are right at the trend line. Also note the broadening formation that formed in May, which is usually indicative of a market top.



On the SMA chart, notice the following:

-- Prices are above the 200 day SMA

-- The 10 and 20 SMA have moved lower

-- The 10 day SMA has crossed below the 50 day SMA

-- The 50 and 200 day SMA are still positive

-- Prices are SMAs are bunched in a close range

What does all of this tell us?

-- The short term trend is down as indicated by the declining 10 and 20 day SMA

-- The overall trend is still higher

-- Whenever prices and SMAs are bunched together in a tight range it indicates the market is looking for a direction about where to move.

Why Transports Matter

From the WSJ:

A sharp drop in freight shipped across the Pacific during the past two months suggests the shipping-industry slump is about to get worse.

At the major ports of Los Angeles and Long Beach, Calif., which bring in nearly two-thirds of West Coast containerized goods, import volume fell 8.8% in both January and February compared with a year earlier, as the weakening economy, tough housing market and high gasoline prices eroded U.S. demand.

.....

Transportation companies like FedEx offer a window into the pernicious effects of a slow economy and rising commodities costs.

Slow growth and high energy costs seem to have squeezed FedEx's third-quarter earnings, due to be reported today. Analysts surveyed by Thomson Financial expect it to post net income of $1.22 a share, down 10% from a year ago.

Rival UPS warned last week that it could miss first-quarter earnings targets after six straight weeks of negative volume in its U.S. package business. Kurt Kuehn, UPS's chief financial officer, said "across a very broad segment of our customers there is a slowing in shipping needs."

High energy prices and weakening demand have also thumped truckers. The American Trucking Associations expects truckers to spend $135 billion on fuel this year, up 20% from 2007. Several trucking companies describe the environment today as the worst they've seen, say Morgan Keegan analysts.

Trouble in transports signals a bad outlook more broadly. FedEx shares tumbled in 1999, before the rest of the market. The "FedEx Indicator" seems to be working well again. Its shares started dropping in July and are down 26% since then. The Dow Jones Industrial Average didn't start slipping until October

Simply put, the transports are a great way to keep track of how the economy is doing. If it's going well, people will have to ship more and more stuff from point A to point B. If things aren't going well, people will be shipping less stuff from point A to point B.

I've touched on the following story before, but it's still very relevant to the current situation:

U.S. airlines, which seemed last year to have shaken off a half-decade slump, may face a new round of restructuring amid a stumbling economy and spiraling fuel prices.

The turnabout reflects the headwinds that have buffeted the industry as oil prices have risen 75% in the past year and the housing slump has mushroomed into a broader credit crisis, making it hard for many businesses and households to borrow and prompting consumers to cut back on spending. Most economists now think the U.S. has slipped into a recession, and the debate is shifting to how deep the downturn will be.

Other industries, from the nation's beleaguered banks to retailers and auto makers, are facing similar pressures. But the major airlines, many of which have spent long periods under bankruptcy protection in recent years, worry they are especially vulnerable.

Let's take a look at some charts.



The transportation index was one of the charts that originally led to to make a bear market call. The index had dropped pretty hard. Since then it has bounced back, although not enough for me to change my opinion about the market's overall direction.

Above is the 5 year chart in one week increments. Notice the clear trend break that occurred at the end of last year. Also note how the index has bounced back since the first of the year.



The three month SMA chart shows the bounce back. Notice how the index moved from lows of around 74 - 76 in January to the current levels in the low 1980s. Also note the average is moving closer to the 200 day SMA. But the rest of the SMA picture is cloudier. Notice that prices and the shorter SMAs (10, 20 and 50) are tightly packed around 81. That indicates there is a great deal of uncertainty about where this average is going. Also notice the average is inching back to the 200 day SMA. A cross above this like and a sustained presence about it could indicate an overall change in the market's thinking about the economy.

Let's take a look at the sub-industries



Airlines are clearly in a downtrend. They've been selling off since the beginning of 2007. Notice at the end of last year they fell through a price level established in late 2005 and then rallied into that level and failed in early 2008. That means there is probably further trouble ahead for this sector.



Rail has a stronger chart. Notice that it hasn't dropped nearly as hard as the broader transport index or the airlines. The sector has been in a consolidation pattern for the last year. Rail has a more solid customer base. For example, they help to transport oil and coal which will be used regardless of the overall economic situation.



Shipping was in a two year price channel in 2005 and 2006. It broke out of that channel in 2007, but has been in a downward sloping pennant pattern since last summer.



Trucking has essentially been in a three year long consolidation pattern since the beginning of 2005. Prices have moved between 240 and 300 on the chart with tow spikes about those levels. But the index couldn't keep the the upward momentum.

Overall, the sub-industries indicate traders are concerned but not panicked about the sector. They're taking some profits, but not aggressively selling.

Why Transports Matter

From IBD:

The railroad operator slashed its Q4 earnings outlook by 20 cents to $1.70 - $1.80 a share, below $1.98 forecasts. Union Pacific (UNP) blamed higher diesel costs. Q4 fuel costs will average $2.60 a gallon — 34% above last year — topping $2.70 this month. Union Pacific also cited weak Dec. traffic due to winter storms. Its shares fell 4%.

Here are some industry charts from Transmatch:



The 13-week rolling average of total traffic is increasing, and has been for awhile. That's a positive development.



But this year's total rail traffic numbers have in general been below last years numbers.

Here's the chart of the transports:



Notice the following.

-- The index is about 8% below the 200 day SMA.

-- Since August, the index has tried to rally above the 200 day SMA twice and been unsuccessful.

-- The 200 day SMA is now heading lower.

-- the 50 day SMA is heading lower.

-- prices are below all the SMAs.

On the good side -- or at least the neutral side we have the following:

-- the shorter SMAs are bunched up, indicating a lot of confusion about where the market wants to go. This is the same situation we're seeing with the big averages.

However --



On the five year chart, notice the index has clearly broken a 3 1/2 year uptrend and is now heading lower. However, the move lower is measured, meaning there doesn't appear to be any panic selling. That's about the only good thing about this chart.

Why Transports Matter and What Inflation?

One company and two, two TWO grand themes!!!!

From the Street.com

FedEx (FDX - Cramer's Take - Stockpickr - Rating) lowered its earnings projection for the current quarter and fiscal year, citing increased fuel costs and weak freight trends.

The parcel-shipping giant now sees earnings of $1.45 to $1.55 for the quarter ending Nov. 30, down from its previous forecast of $1.60 to $1.75. Analysts polled by Thomson Financial anticipated earnings of $1.70 a share.

For the full fiscal year, FedEx projects earnings of $6.40 to $6.70 a share. Its prior view called for a profit of $6.70 to $7.10 a share; analysts had an average forecast for earnings of $6.85 a share.

FedEx had already offered weaker-than-expected projections for the periods in its first-quarter report in September. But the company said Friday that its fuel costs have increased 8%, or $85 million, since that time.

This is not the first time Fed Ex has recently warned about earnings. From September 20:

FedEx (FDX - Cramer's Take - Stockpickr - Rating) said earnings rose for the just-completed quarter, but the package carrier reduced its forecasts for the current quarter and the full year because of economic uncertainty.

The company encountered "a U.S. economy slowed by a sharp correction in the housing market, financial volatility and high energy costs," said CEO Fred Smith, on a conference call.

The impact was particularly severe at FedEx Freight, owing to the housing market's effect on the less-than-truckload transportation market, he said. Still, strong international results led to profit growth.

Federal Express is the second largest company in the air services and freight sector. UPS is about twice as large. In other words, what Fed Ex say is very important for the overall economy. And what they are saying isn't very good.

Dow theory says the transports have to confirm the broader markets. The underlying logic is simple. If the economy is expanding, we'll have to ship more and more stuff. Conversely, if the economy is contracting, we'll be shipping less and less stuff. The logic is pretty much irrefutable.



The transports say we're in trouble.

1.) The index is below the 200 day SMA, and has been there since early August.

2.) The shorter SMAs are below the longer SMAs.

3.) All of the shorter SMAs (10, 20 and 50) are moving lower.

4.) prices are below the SMAs.

Also note Fed Ex's statement about fuel costs. Fuel costs have increase 8% . That's a huge increase for a company that depends on oil costs.