Does the drop in Dow Transport tell us anything?
The link between the Dow Jones Transportation Average and the more familiar Dow Jones Industrial Average is as old as the hills. If the indices move up in tandem, the US economy is seen to be doing well because industry is gaining and transportation is taking. However, if transportation begins to decline, especially before similar moves in the industrial average, then the perception is that the economy is slowing because shipping demand, historically a leading economic indicator, has weakened.
The correlation is no longer as strong as before. Transportation is nowhere near as dominant as when the 20-stock index was formed in 1884 and railroads were arguably the country’s most important industry. The 30-stock industry average, which emerged 12 years later, now includes technology companies and retailers that would not be associated with the companies that have made up the average for most of its history.
Yet the link still exists. The Dow Theory, which predicts overall market trends based on whether the two indices confirm upward moves or diverge, is used by some traders to guess changes in market cycles. Freight slumps have in the past preceded broad economic downturns, the idea being that weakening demand for transportation telegraphs a slowdown in orders and production activity.
Which brings the world to what is happening today. The transport average is going through one of the worst commercial periods in its history. Over the past eight trading days through Friday, the average has fallen more than 13%. The average rebounded slightly on Thursday after six straight days of declines, dropping 0.95% on Friday to close at $14,470.72, a six-month low and down 2,300 points in the past eight sessions. Not since the spring of 2020, when the COVID-19 pandemic crippled much of the US economy and the index was roughly halved, has the carnage been so severe.
It didn’t help that longtime Bank of America Securities transportation analyst Ken Hoexter downgraded nine of the 28 stocks in his coverage universe on Friday.
The recent action has not been lost on mainstream business and financial media. On Tuesday, veteran columnist Mark Hulbert wrote on financial platform MarketWatch that transportation is “in a ditch. Can the stock market and the economy be far behind? The next day, Al Root, a columnist for financial publication Barron’s who knows the industry well, wrote that “another recession indicator just flashed red.”
But will transportation be such a reliable indicator this time around, especially in light of what the US and global economies have been through since April 2020? There has been nothing normal in the past two years. Domestic demand has reached unprecedented levels and has only recently started to calm down. This has led to the strongest trucking market in three decades. Conversely, the second half of March, which has historically been one of the trucking industry’s strongest periods, saw weakness in nearly every measure of demand.
One school of thought is that transportation is massively reverting to mean, which could bring demand trendlines back to pre-COVID levels. The fiscal stimulus is running out of steam. Consumer spending is shifting more towards services, especially as warm weather approaches. Retailers who have stocked their warehouses with inventory to protect against supply chain disruptions may not need to place new orders anytime soon. Markets have begun to discount these events by hammering the shares of truckload carriers, package carriers, and anyone else who makes a living transporting retail goods.
By contrast, rig demand and pricing, both of which reflect the state of industrial activity, continue to grow at a healthy pace. Jason Miller, associate professor of logistics at Michigan State University’s Eli Broad College of Business, said machine production in February, on a seasonally adjusted basis, exceeded the previous production peak of late 2018. and soy buy equipment. Add to that the new $1.2 trillion infrastructure spending program and a continued increase in housing starts, and all indications are that demand for flat services should remain strong for months, he said. .
The current drop in the transportation average signals more of a return to long-term trends than an impending recession, according to Miller. He pointed to data from the Chicago Federal Reserve showing a sharp drop in March inflation-adjusted sales in retail trade and food service sales, excluding motor vehicle and parts dealers. However, the drop represents a return to the pre-COVID trend line from January 2019 to February 2020, he said.
Miller said consumer spending had been so high since the March 2021 federal stimulus package that it was only a matter of time before demand cooled. “The bottom line is that the drop in spot prices for the dry van sector suggests that the ability of truckload haulers to command further price increases will decline, which is why their shares have been hit.”
Jason H. Seidl, transportation analyst for Cowen & Co., said a lot of cross-currents were rocking transportation stocks. Higher inflation pinches consumers and can lead to demand destruction. Services increasingly compete with goods for consumers’ money. Spot market prices have moved off their highs. Trucking seasonality is anything but, with weakness appearing in what is normally a very strong time of year. Platform demand and prices remain firm, he said.
In a Wednesday memo, Seidl said trucking and logistics executives told him that lower demand for full truckloads has boosted tender acceptance rates and reduced trucker costs by mile. Recruiting drivers has become easier as more people return to work, though equipment shortages remain an issue, Seidl said. A large shipper that Seidl did not identify said 30% of its freight was moving in the spot market compared to last year, when all of its business was under contract.
Although the market for truckload contracts has yet to turn south, low spot rates, which typically lead to three- to six-month contract moves, make a decline in contract prices very likely, a said Seidl. A brokerage executive said the company is seeing record gross profit margins per load as margins remain high as rates fall.
Anecdotes aside, Seidl said in an interview on Tuesday that there wasn’t enough data from April to shed some light on where the market is going. It will take at least until the middle of the month for the data points to guide him on future trends.
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