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U.S. Losses May Signal Market Drop

New York, Bloomberg

By Nick Baker
August 14, 2006

Airlines, railroads, shippers and truckers are among this quarter's worst-performing U.S. stocks, and their performance may foreshadow more widespread losses.

The Dow Jones Transportation Average fell last week for a sixth straight week, the longest losing streak since March 2003. Continental Airlines Inc. had the steepest retreat as news of a foiled plot to blow up planes bound for the U.S. from the U.K. sent airline shares tumbling.

United Parcel Service Inc., the biggest company in the 20- stock average by market value, recorded its worst one-day drop ever in July after reducing its profit forecast.

The industry's slump suggested to some investors that economic growth is slowing. For followers of Dow Theory, an indicator developed in the 19th century, the decline set off a warning that the market may be poised to fall.

"A significant deterioration in transports will turn up in industrial earnings," said Andy Engel, an analyst at Leuthold Group in Minneapolis who helps oversee US$2 billion. "It will bring the whole market down."

The Dow transports last week tumbled 5.4 percent, its biggest decline in 14 months, to 4141.62 as concern that the Federal Reserve's interest-rate increases may restrain economic growth sent share prices lower.

The Dow Jones Industrial Average slipped 1.4 percent for the week, to 11,088.03, and has lost 0.6 percent this quarter. The Standard & Poor's 500 Index retreated 1 percent to 1266.74 and the Nasdaq Composite Index slumped 1.3 percent to 2057.71.

For the third quarter, every company in the transportation average has dropped except Overseas Shipholding Group Inc., the largest U.S.-based owner of oil tankers. The average has fallen 16 percent, which would be the worst quarterly loss since 2002.

Continental, the fourth-largest U.S. airline, plunged 17 percent last week. AMR Corp., the owner of American Airlines, sank 14 percent. Both stocks are down 26 percent this quarter.

The third-quarter declines are the biggest among the average's members aside from a 30 percent drop in Expeditors International of Washington Inc., the country's second-biggest manager of freight shipments. J.B. Hunt Transport Services Inc., the third-largest U.S. trucking company, has lost 23 percent.

UPS, the world's largest package-delivery company, has fallen 19 percent. The stock plunged 10 percent on July 25, when the Atlanta-based company said earnings growth for 2006 would be "at the low end" of the 11 percent to 16 percent range set in January. The loss was the biggest since UPS went public in 1999.

Union Pacific Corp. has slipped 15 percent even though the biggest U.S. railroad's second-quarter profit and third-quarter forecast beat estimates.

The presumption that transportation stocks are a harbinger for U.S. economic and stock-market performance dates to the late 1800s, when the Wall Street Journal co-founder's, Charles Dow, created the industrial and transportation averages. Dow argued that when growth at manufacturers slows, railroads and other transporters get less business.

Transportation companies are still a valuable indicator today, according to Leuthold. The effect of economic slowdowns shows up faster there because data on their business, including railroad freight shipments and airline travel, is released more often than the quarterly schedule in other industries.

"By using transports as a check, you have a better chance of keeping your money on the right side of the trend," said Richard Moroney, editor and director of research with Dow Theory Forecasts in Hammond, Indiana.

The U.S. economy's expansion slowed to a 2.5 percent annual rate in the second quarter, and the Federal Reserve forecasts a similar pace for the rest of 2006. Gross domestic product grew at a 5.6 percent rate in the first quarter, and averaged 3.1 percent since the last recession ended in November 2001.

Speculation that the economy may cool further has made investors more pessimistic. According to Investors Intelligence, 37.1 percent of investment-newsletter writers were bearish in the week ended Aug. 4, the highest percentage since March 2003.

Slowing growth may worsen the earnings outlook. Second- quarter profit rose 16.3 percent for S&P 500 members, based on already reported results and estimates for the rest, according to Thomson Financial. Analysts expect the pace to slip to 14.5 percent this quarter and 13.6 percent in the fourth quarter.

Wal-Mart Stores Inc., the world's largest retailer, is among companies set to release quarterly profit reports this week. Others include Dell Inc. and Hewlett-Packard Co., the No. 1 and No. 2 makers of personal computers, and Home Depot Inc., the world's biggest home-improvement retailer.

As companies such as UPS reported their results, the Dow transports fell beneath a low reached on June 13, pointing to a market decline in Dow Theory. The indicator holds that when the average and the Dow industrials reach lows at the same time, stocks are imperiled. The industrials are still 3.6 percent above their low point.

"The transports are probably telling us that we're in trouble," said Richard Russell, publisher of the La Jolla, California-based Dow Theory Letter. "We'll know that we're in trouble when the Dow industrials breaks down."

Transportation stocks comprise just 1.7 percent of the S&P 500, so their decline has relatively little effect on its value. The index's biggest industry groups -- financial, technology and health-care companies -- represent 22 percent, 14 percent and 13 percent of the gauge, respectively.

Still, investors see transportation shares as a predictor of impending stock-market losses. The Dow transportation average fell 40 percent from May 1999 to March 2000, when the so-called Internet bubble began to burst. The Dow industrials peaked in January 2000 and tumbled 38 percent through October 2002.

Declines among airlines, railroads, shippers and truckers have "proved quite useful in predicting economic weakness and stock weakness," Leuthold's Engel said. "We're negative on the stock market."

Please note that the discussion of the investments and investment strategy of Horizon Investment Services, LLC (including Horizon’s research and investment process) represent the investments and investment strategy of Mr. Moroney and Horizon at the date of the article, and are subject to change without notice. Horizon cannot assure that the type of stocks mentioned in the article will outperform any other investment strategy in the future, nor can it guarantee that such stocks will present the best or an attractive risk-adjusted investment in the future. References to an individual security should not be construed as a recommendation to buy or sell that security. In addition, the securities noted in this article are but several of the many successful, as well as unsuccessful, investments by Horizon and do not represent all of the securities that Horizon has purchased, sold or recommended to clients. Horizon cannot guarantee the accuracy or completeness of any statements or numerical data in the article. Past performance is no indication of future results.