Why it is important that transportation indices stay on the rails

Helped by election defeats for (so-called) populist far-right and far-left parties in Austria, the Netherlands and France, markets appear to be getting over their attack of political jitters - even allowing for the imminent UK General Election and the kerfuffle in the US over the sacking of FBI chief James Comey, the lingering effect of which remains loose talk over whether President Trump could be impeached.

A repeat of 1974’s proceedings against Richard M. Nixon (which led to his resignation) and 1998’s impeachment of Bill Clinton (which ended in his acquittal just three months later in February 1999) seems unlikely for now.

And while we can never say never, given the particularly febrile nature of politics in Washington right now, this means advisers and clients can put the lurid headlines to one side and get back to focusing on market and economic fundamentals.

As regular readers will know, one of this column’s favourite indicators which marry markets with economics are transportation stock indices, notably the Dow Jones Industrial Transportation benchmark in the USA and the FTSE All-Share Industrial Transportation index here in the UK.

This predilection is largely based upon the late Richard Russell’s Dow Theory.

The logic here is that it can only be good news if the share prices of the firms moving goods around the world by road, rail, sea or air are doing well. If something is sold, it has to be shipped. Equally, weak transport stocks could mean inventories are piling up on shelves and forecourts, to herald production cuts and a potential downturn in industrial activity, economic output, corporate earnings and potentially stock market valuations.

Now seems a good time for an update, not just in the USA but worldwide, given ongoing confusion over whether global economic activity (and by extension corporate earnings) are accelerating or not.

Share prices seem convinced that the reflation trade is the right one but bond markets less so. In the latter case, Government bond yields have come off their highs in the US and UK and the gap between the US two- and ten-year Treasury yields is narrowing in a manner which means the so-called ‘yield curve’ is flattening – a trend which can warn of a slowdown ahead.

A flattening yield curve in the USA is a potential warning of an economic slowdown ahead

Source: Thomson Reuters Datastream

America

Throughout 2015 the Dow Jones Transportation index led the better-known Dow Jones Industrials higher in classic ‘bull market’ fashion.

The Transports then lost momentum in early 2016 but gathered steam upon the election of Donald Trump as US President in the late autumn.

However, that boost did not last long and for all of the broader US market’s enthusiasm for Trump’s planned reform programme, the Transport index has refused to lead the Dow Jones Industrials, S&P 500 or NASDAQ Composite.

The loss of momentum in the Dow Jones Transportation index is a potentially worrying sign

Source: Thomson Reuters Datastream

They have reached new peaks but the Transports index has not and this trend commands attention. If it continues for too long it could be a warning sign that all is not well with either the US economy, its stock market, or both.

UK and Europe

Thankfully for any bullish advisers and clients, the news from British and European transportation indices is more encouraging.

The FTSE All-Share version is trending higher – despite the deadening presence of the ex-growth Royal Mail plc – while the Euro Stoxx transport benchmark is powering higher.

The latter looks to reaffirm the positive impression created by a 26-year high in the German Ifo industrial confidence indicator and the six-year peaks reached in the German and French purchasing managers’ indices (PMIs) for May.

The UK and European transport indices look much more robust

Source: Thomson Reuters Datastream

For the moment, the Eurozone economy continues to surprise on the upside, helped by weakness in its currency and oil, as well as highly accommodative monetary policy and an easing of the fiscal squeeze which characterised the bloc in the wake of the early stages of the Greek debt crisis.

Japan and Asia

Japan has just posted its first string of five consecutive quarters of annualised GDP growth for a decade. A solid advance in both the Nikkei Air Transport and Land Transport indices seems to make sense, given such a backdrop, as the Nikkei 225 headline index moves toward 20,000 for the first time since late 2015.

Japan’s air and land transport indices are also powering higher

Source: Thomson Reuters Datastream

China remains a key source of global economic uncertainty – a Chinese growth scare hit global stocks hard in both summer 2015 and early 2016, before the authorities stepped in with a powerful combination of fiscal and monetary stimulus.

That appears to be propping up the national GDP growth numbers and keeping them in the target 6.5% to 7.0% range for 2017 ahead of the all-important 19th Communist Party Congress this autumn.

Yet the Shanghai Composite index’s retreat to a six-month low reflects concerns that the growth relies too much on stimulus and debt, with the result it may not be sustainable.

As soon as the authorities tightened liquidity to cool a hot property market global commodity prices swooned. At least advisers and clients can draw some comfort from the Chinese and Shanghai Containerised Freight indices, which have rallied hard from their 2015 lows around the 400 mark. Further progress would offer some comfort that China remains on track, but the real test will come if the People’s Bank of China moves to further tighten monetary policy.

Chinese freight indices have recovered strongly

Source: Thomson Reuters Datastream

Summary

To further the impression that growth in China is powering improvement around the world, the Baltic Dry index made strong progress for much of 2016.

This benchmark takes in 23 shipping routes on a time charter basis and looks at the rates for moving commodities such as grain, iron ore and coal around the globe.

However, it has slipped lower of late, which does temper enthusiasm for the global outlook a little, even if the Baltic Dry’s gyrations will not just reflect global demand but the supply-side dynamics of global bulk shipping.

Baltic Dry index has sagged of late

Source: Thomson Reuters Datastream

Moreover CPB Netherlands Bureau for Economic Analysis’ World Trade Monitor shows a marked acceleration in global trade volumes in early 2017.

World trade flows have jumped higher in 2017

Source: CPB Netherlands Bureau for Economic Analysis World Trade Monitor, March 2017

That is probably the most encouraging chart, whereas the Dow Jones Industrial Transportation index with which we began is probably the most worrying one. This column will continue to track all of these indicators in the coming weeks and months.

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.

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