Bloomberg News

Dow Theory Converging With Bonds as Transports Signal Slowdown

March 12, 2012

Laszlo Birinyi, president of Birinyi Associates Inc., said “The race is still on.” Photographer: Scott Eells/Bloomberg

Laszlo Birinyi, president of Birinyi Associates Inc., said “The race is still on.” Photographer: Scott Eells/Bloomberg

Transportation and industrial shares are diverging in the U.S., a signal that equity investors are starting to agree with what the bond market already knows: this economic recovery will remain sluggish for months to come.

The Dow Jones Transportation Average fell 4.2 percent from its six-month high on Feb. 3 through today, while the Dow Jones Industrial Average (INDU) added 0.8 percent. The gauge of 20 shipping companies from FedEx Corp. to United Continental Holdings Inc. (UAL) peaked before the rest of the market when the technology bubble popped in 2000 and began slipping into a bear market three months before broader benchmark indexes in 2007.

While Laszlo Birinyi, the founder of Birinyi Associates Inc., says falling transport stocks don’t signal an end to the three-year bull market that doubled the Standard & Poor’s 500 Index (SPX), money managers at Robert W. Baird & Co. and Legg Mason Inc. say the 27 percent rise in the index since October may have gone too fast. Transport stocks are falling as 10-year Treasury yields (USGG10YR) stay near 2 percent, with economists forecasting the slowest post-recession recovery since World War II.

“In a healthy market, everything is going in the same direction,” Bruce Bittles, chief investment strategist at Milwaukee-based Robert W. Baird, which oversees $85 billion, said in a March 6 phone interview. “When that starts to diverge, that raises a flag that potential trouble may be brewing.”

China, Europe

The S&P 500 rose 0.1 percent to 1,370.87 last week, with gains in the final three days helping the index avoid its second weekly slump of the year. Stocks advanced after U.S. employers added more jobs than forecast, helping the S&P 500 recover from a 1.5 percent drop on March 6 that was the largest loss since Dec. 8. Equities had fallen after China lowered its growth target and a report showed the European economy contracted 0.3 percent last quarter. The S&P 500 ended little changed at 1,371.09 today.

Investors say they are growing concerned about the pace of the rally, partly because Dow Theory says the transportation and industrial averages must move higher in tandem for market rallies to last. The gauge of railroads, trucking companies and airlines has slumped since the end of January as the Citigroup Economic Surprise Index (CESIUSD), which shows the degree to which reports beat median estimates in Bloomberg surveys, fell 58 percent from this year’s high.

Market Cycles

Birinyi, among the first to recommend buying stocks as the market reached its bear-market bottom on March 9, 2009, said last week that declines in shipping and smaller companies don’t mean the rally is ending. He remains bullish, based on an analysis of market-cycle lengths.

“The race is still on,” Birinyi, founder of the Westport, Connecticut-based firm, said in a Bloomberg Television interview on March 8. “There’s always something that doesn’t fit the scenario.”

This rally must last another year to match the average length of bull markets since World War II ended, according to data compiled by Birinyi Associates. Eight of 13 lasted longer than this one, including the eight-year advance in which the S&P 500 quadrupled through 1998 and the advance from 1982 to 1987, when the index more than tripled, the data show.

The S&P 500 and Dow industrials rallied during the past five months as demand for Treasuries kept 10-year yields no more than 0.16 percentage point above 2 percent since Nov. 1. The rate fell to a record low of 1.6714 percent in September as investors sought the relative safety of U.S. government debt on concern that Europe’s debt crisis and slowing growth in China would derail the global recovery.

‘Bipolar World’

“You have this bipolar world with very different views on the direction of global economic growth,” Wayne Lin, a money manager at Baltimore-based Legg Mason, said in a phone interview on March 8. His firm oversaw $631 billion as of Jan. 31. “I tend to lean a little more on the bond side just because I see that earnings growth is starting to turn over and there seem to be decelerating economic activities in Europe.”

Treasury yields slid as Federal Reserve Chairman Ben S. Bernanke kept interest rates near zero since December 2008 and expanded the central bank’s balance sheet with two rounds of asset purchases totaling $2.3 trillion. Bernanke told lawmakers on Feb. 29 and March 1 that elevated unemployment and subdued inflation mean interest rates are likely to stay low.

Slower Growth

The U.S. economy will expand 2.2 percent this year, according to the median forecasts of 79 economists in a Bloomberg survey. While that’s up from 1.7 percent in 2011, it’s less than the 3.7 percent average from 1983 to 2000.

Gross domestic product has expanded at an average annual rate of 2.5 percent since the recession ended in June 2009, making this the weakest recovery in at least six decades, according to data compiled by Bloomberg. Even though the U.S. has grown for 10 straight quarters, average hourly earnings rose 1.9 percent in February, near the smallest increase since April, and down from 3.7 percent in January 2009, Labor Department data show.

“The economy is going to strengthen, but it’s going to be a subpar recovery,” Jeffrey Saut, chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said in a phone interview on March 7. His firm oversees more than $300 billion. A level of “1,400 is doable this year on the S&P. Beyond that, we have to see how strong the recovery is,” he said. Should the S&P 500 end 2012 at 1,400, it would be an 11 percent gain for the year, or the third-biggest annual advance in six years.

Stocks of shipping companies peaked ahead of other equities in the two previous bull markets. While the technology bubble didn’t end until March 2000, the Dow transport average was already down 29 percent from its peak 10 months before.

Great Depression

The measure began its retreat three months before the S&P 500 hit an all-time high of 1,565.15 on Oct. 9, 2007 and gave way to the worst economic contraction since the Great Depression, which began after December 2007.

While S&P 500 companies exceeded analysts’ profit forecasts for a 12th straight quarter, earnings-per-share for the 472 companies that reported from Jan. 9 through March 9 rose 4.9 percent for the slowest rate since 2009, data compiled by Bloomberg show. Income will increase 13 percent this year, slowing from an average rate of 16 percent in the previous three years.

Earnings at FedEx (FDX), operator of the biggest cargo airline, slipped before the 2008-2009 recession. The Memphis, Tennessee- based company posted its first profit decline in more than five years in the three months ended February 2007, about four quarters before GDP contracted 1.8 percent.

The shares peaked at $120.97 on Feb. 23, 2007, almost eight months before the S&P 500’s all-time high. Now, they are down 5.8 percent since reaching a seven-month high on Feb. 13, compared with a 1.4 percent climb in the S&P 500.

United, Overseas Shipholding

United Continental of Chicago has helped lead airlines lower since Feb. 3, falling 21 percent as oil futures approached $110 a barrel in New York. Overseas Shipholding Group Inc. (OSG), the largest U.S. crude-tanker owner, plunged 30 percent in the same period after the New York-based company said it will stop loading cargoes in Iran amid tightening sanctions on the Persian Gulf nation.

The Dow transportation gauge fell 3.1 percent in February, compared with a 2.5 percent gain in the Dow industrial index. Since 1930, there had been 20 previous months when they moved in opposite directions and shipping companies lagged behind at least 5.6 percentage points, data compiled by Bloomberg show. The S&P 500 lost 1.4 percent on average in the following month, and was up 8.2 percent a year later, the data show.

“This is probably the start of something of a short-term topping process for the S&P 500,” Gina Martin Adams, a strategist at Wells Fargo Securities LLC in New York, said in a March 8 Bloomberg Television interview. “We’re not suggesting it’s anything more onerous than a signal that we probably have a little bit of a correction coming.”

To contact the reporters on this story: Lu Wang in New York at lwang8@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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