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Transports Are Lagging. So What?

In recent years, using the sector as an indicator just hasn't worked


Any time the Dow Jones Transportation Average (DJT) is lagging, it’s bound to attract plenty of media attention — and that’s the case right now. Using iShares Dow Jones Transportation Average Index Fund (NYSE:IYT) as a proxy, the transports have returned -3.1% since June 30. That’s well behind the 2.6% gain of the SPDR Dow Jones Industrial Average ETF Trust (NYSE:DIA).

According to the modern interpretation of Dow Theory, this sort of underperformance for the transports should be a negative sign for the broader market. Unfortunately, it hasn’t worked that cleanly in real life. A look at recent history shows that a shortfall in the transportation average has been a highly ineffective gauge of future market direction.

During the past three years, on six occasions the IYT has underperformed DIA by a sizeable margin, as illustrated by the black lines in the chart below. A rising line indicates outperformance for transports versus the Dow, while a falling line indicates underperformance.

On the majority of occasions, the broader market (as gauged by DIA) has closed the subsequent one-, three- and six-month periods in positive territory, and sometimes dramatically so:

Interval IYT DIA DIA, + 1 mo. DIA, + 3 mos. DIA, + 6 mos.
1/31/12 – 2/22/12 -3.6% 2.7% 1.0% -2.7% 2.9%*
7/1/11 – 9/30/11 -8.4% 7.7% 9.7% 12.6% 22.6%
1/13/11 – 2/23/11 -4.5% 3.5% 0.0% 2.8% -6.7%
5/1/10 – 7/6/10 -18.2% -12.1% -1.6% 8.1% 14.6%
12/16/09 – 2/8/10 -8.9% -4.8% 6.7% 5.0% 8.6%
9/15/09 – 10/30/09 -10.7% 0.4% 7.1% 4.3% 14.6%
Average 3.8% 5.0% 9.4%

* Partial period, 2/22/12 – 8/13/12

How could such a popular indicator be so inaccurate? The likely answer is that the three-year period in question has been dominated by the risk-on/risk-off trade. And transport stocks, due to their higher level of economic sensitivity, are more likely to underperform during periods of weak data than the Dow, a little over half of which is in steady, defensive names such as IBM (NYSE:IBM) and McDonalds (NYSE:MCD).

As a result, the transports have lost some of their luster as a leading indicator. Futher, the original thinking behind this aspect of Dow Theory (“the industrials make, the transports take”) is much less accurate now since the bread-and-butter of so many Dow components these days is consumer staples or intellectual property.

The message here isn’t that the recent underperformance of IYT indicates that a rally is at hand. Quite the contrary: According to the market’s actual performance results, it doesn’t tell us anything at all. In addition, the broader trend of the past three years has been generally upward, so it’s only natural that periods of weakness would be followed by a rebound.

Instead, the takeaway is to give less weight to the flood of articles that comes out screaming “sell signal!” every time the transports lag for more than two weeks. The recent results just don’t support the hype.

Article printed from InvestorPlace Media,

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