One of the key points I’ve been emphasizing on the radio show (besides Europe) is the non-confirmation of the Dow Jones Industrial Average by the Dow Jones Transportation Index. I also mentioned last week that this was one of the factors in the process of forming a market top. While this is a warning sign, it is not a signal to become bearish on stocks.
Dow Theory
One of the tenets of Dow Theory is that the Transport and Industrial indexes need to confirm each other’s trend. The closer in time that each gives a specific buy or sell signal, the stronger the signal. When one diverges from the other, it’s called a non-confirmation. In the present scenario, the Industrial Average is printing new 4-year highs while the Transport Index continues a sideways trend that started in February. While not as bullish a situation as having both averages printing new highs, non-confirmation is not a bearish signal to sell or not participate in the market. In Dow Theory, it is assumed that the prior trend (or signal) is still intact despite the divergence.
So what was the previous signal or trend? Before the Dow Jones Transport index began its sideways trend in February, it was in an uptrend with a bottom set a year ago. Both the Dow Jones Industrial Average and the Dow Jones Transport Index gave a clear Dow Theory buy signal in January when they both confirmed a bullish reversal in trend, and that hasn’t changed since. A bullish reversal is simply higher lows confirmed by higher highs (see chart).
As you can see from the chart, the Industrials and Transports diverged around July. The Transports formed a lower high while the Industrials began a trend that has broken the April highs. While the Transports have set in a lower high in July, this lower high has not been confirmed by a break to new lows. As such, I’m saying that the Dow Transports are not in a downtrend, but simply a sideways trend. While both indexes continue to diverge from one another, we will have resolution to the divergence and I believe it will be to the upside for the following reasons:
- Transports at technical support
- A pickup in manufacturing and regional economic surveys
- Holiday shopping season
- Wall Street buy recommendations
Support
Technically speaking, the Transport Index is at support near the May lows. If the May lows break, it will signal a top. If the index can break above 5200, it will signal a breakout from the existing sideways trend. Currently, the Transport Index is bouncing off support. That may be due to the plethora of buy recommendations hitting the group or the stronger ISM numbers we got this week.
Manufacturing Turnaround
The ISM Manufacturing index rose for September. Not only did it rise, but it is now in the expansionary zone with a reading of 51.5. What’s more, the new orders (a leading indicator) and the employment index surprised expectations. Production increased and inventories dropped. Another increase was in supplier deliveries. Manufacturing is likely to pick up due to the holiday season and production that had halted in the third quarter. However, with the fiscal cliff square ahead, without any resolution to date yet from Congress regarding tax hikes and spending cuts, the manufacturing industry isn’t likely to be robust.
Source: https://www.economy.com/dismal
There was some discrepancy between the Richmond Fed and the Kansas City Fed Manufacturing surveys last week. While the Richmond Fed survey entered positive territory for September with two consecutive monthly increases in activity, the Kansas City Fed survey showed a drop in activity. The Kansas City Fed survey has been volatile all year, but it was still able to squeak by with an expansion ready. The last time the region registered a contraction in activity was in December, briefly for one month. The Kansas City manufacturing Survey has shown expansionary readings for all but one month since late 2009 after a dramatic recovery mid-year. The peak in activity came in early 2011. The region has muddled along consistent with the broad prognosis that the U.S. is growing, very slowly.
Tying in Activity to the ISM
For our consumption-led economy, the proof of consumption is the movement of goods. If goods aren’t getting moved around from manufacturer to retail store or directly to the consumer’s home, then the consumption cycle is slowing. We need demand to be happening to have growth.
Cass Information Systems is a provider of transportation, utility, waste, and telecom expense management and related business intelligence services. According to Bloomberg, Cass compiles the transportation volumes and expenses on 1500 companies across a very diverse group. This sampling provides a valid cross-sampling of industries in the U.S. on a month to month basis. As the index shows, shipments dropped in the fourth quarter last year (recall worries over Europe) and has picked up again in 2012.
Source: Cass Information Systems
Since European worries set in again around May, notice the index has dipped for both activity and expenses. Then the question we need to ask ourselves: is this dip the beginning of a new trend or just a lull in an ongoing recovery story since 2009? With manufacturing turning back up as well as leading indicators inside those indicators, it’s likely the European worries are behind us and the fourth quarter should turn production around. To support this thesis we turn to the consumer.
Have a Holly Jolly Christmas
The Holiday shopping season is right around the corner. Online shopping is in a secular bull market. Shop.org, a division of the National Retail Federation trade group, stated on Tuesday that online holiday sales will increase 12% this year. That means UPS and FedEx will be busy delivering your Amazon purchases to your doorstep. The thing is, it isn’t just Amazon that’s cashing in on the secular trend. Many retailers have their own online website. Direct marketing has dramatically increased since the age of the internet. Direct marketing and purchases result in direct distribution and the channels it takes to get the digital image you placed in your online shopping cart to your doorstep.
Source: www.internetretailer.com
It’s not just a U.S. phenomenon. E-commerce is growing on a global scale with projections of more than 19% growth per year as predicted by Goldman Sachs.
Source: www.internetretailer.com
An important question to ask here is how is the American Consumer? Well, we get reports on a monthly basis regarding sentiment and confidence. Just last week we got the Conference Board index of consumer confidence, which surged in September to 70.3 from 60.6, the highest reading since February. This was a dramatic increase that blew away expectations by economists. This significant driver behind the reading was based on future expectations with a modest increase in present conditions. The consumer is more confident about our future even though businesses aren’t with 25% of the S&P 500 warning heading into the earnings season next week. Have expectations been tempered enough? Let’s take a look at Wall Street’s prognosis.
Where the Rubber (Rail) hits “The Street”
Recently we’ve heard from the management of United Parcel Service (UPS), Federal Express (FDX), and Norfolk Southern (NSC) concerning their activity and outlook ahead and the market has not liked what it has been told. That explains the recent sell-off in addition to recent shipment activity (or lack of). So we got a report during the slow summer quarter and management has under promised on future activity. You know the drill by main street management…under promise and over achieve. Looking forward, Wall Street is beginning to make some buy recommendations.
Bank of America raised J.B. Hunt Transport Services (JBHT) to a buy on September 12th. They admit that their buy recommendation is value oriented, but they believe that “fears about a soft 3Q12 trucking and intermodal results and resultant earnings pressure are built into expectations.” They also note that their major rail partner (Norfolk Southern) is increasing intermodal terminal capacity. Intermodal freight transport is the use of multiple modes of transportation to handle goods from A to B. Norfolk Southern intends to add up to 34 new service lanes in 2013 which is a positive catalyst for J.B. Hunt.
Federal Express lowered guidance for the full year just a couple of weeks ago. There’s an Investor Day and Lenders Meeting in Memphis next week so we’ll be hearing more about the company. Ahead of that meeting, research groups will be talking about the stock. Recently today, Deutsche Bank reiterated their buy-rating heading into the meeting citing a good setup for the shares with tempered guidance and the potential for cost savings.
For most of the trading today, Ryder Systems (R) was the top performing S&P 500 stock. After announcing studio truck rentals for the film industry on Monday, it wasn’t until today that the Wall Street made some buy recommendations including Jim Cramer, and SunTrust recommended it as a buy. Zacks Research Analysts increased their rating as well on Ryder on September 27th last week.
Barclays research dissected Norfolk’s earnings miss and their work suggests that Norfolk’s greater exposure to coal price volatility as the main culprit compared with its peers. They are confident the drivers behind the miss were company-specific and despite its coal earnings volatility, valuation levels across the peer group “prove attractive”, especially for CSX Corp (CSX).
Conclusion
Will the Dow Jones Transport Index be the demise of the ongoing bull market in stocks? Based on a technical review of support, the turnaround in manufacturing and consumer confidence, the Holiday retail season around the corner, and the growing consensus by Wall Street – the answer is no. The stock market’s trend continues to hold since the May correction despite a slowdown in economic activity. The Transport Index, while not robust, has not signaled a declining trend to date and is likely to catch a bid here, especially with all of the factors I’ve mentioned. A drop in crude prices over the past three weeks is the icing on the cake.
