Why one of the oldest market-timing signals is worrying investors

Share

Something has been worrying investors who stand by one of Wall Street's oldest market-timing signals: The Dow Jones Transportation Average, a 20-member index of railroads, airlines, marine shippers and package delivery companies, has been slumping since the beginning of the year. To some veterans, this suggested that the broader Dow Jones Industrial Average – and the U.S. stock market as a whole – was headed for trouble. Sure enough, stocks plunged in August.

The crash fit in with the Dow Theory, distilled from the writings of Charles Dow, who founded the Dow Jones market indexes and The Wall Street Journal in the 19th century. One of the central tenets of the theory says that transportation stocks should move with the broader market because the transports deliver the products that other companies make.

The theory has a strong historical track record. The disconnect between the transports and the industrials would have let you escape most of the carnage following the crash of 1929, the implosion of the dot-com bubble in 2000 and the financial crisis of 2008-09. When the indexes moved in tandem, the theory sent buy signals during the market depths of 1933 and 2009.

But are there flaws with the theory? Alas, yes. Different analysts apply it differently. There can also be lots of short-term buy or sell signals, so investors have to be nimble.

The underlying rationale has also changed dramatically. When Dow created the indexes in the 1880s, the United States was a manufacturing powerhouse, and rail was the dominant mode of transport. But both the industrial and transport indexes have grown more diversified over time, yet less representative of the economy and the stock market as a whole. It is now unclear whether the two averages should move together. According to New York City-based Birinyi Associates, the Dow Theory is a lagging indicator that can't anticipate much at all.

Still, the transportation average itself is an interesting investment. The 20 stocks in the index now include FedEx, railroad Union Pacific, Southwest Airlines and tank barge operator Kirby Corp. Although the index is cyclical, it has performed well over the long term: It has beaten the Dow industrials over the past three-, five– and 10-year periods. Blackrock's iShares offers a Dow transports ETF, and State Street's SPDR family of ETFs has a transportation fund.

If you dig deeper into the transports, you might also find bargains. Airlines have soared in recent years, but railroads have struggled. If you're a contrarian, the railroads could be worth a look.

Finally, the transportation average reveals that on e of the stronger investment themes of recent years –package delivery–has stalled. FedEx and United Parcel Service are down this year over concerns about slow global economic growth. The long-term trend driving them remains, however: As consumers order more things online, the companies that drop off the books, shirts and eyeglasses will be kept very busy.