July marked the end of the road for the rally in transportation stocks, and while the sector is seen as a bellwether, investors say its swoon could actually be a bullish sign for the broader stock market.
Investors are weary after 17 consecutive interest-rate increases by the Federal Reserve and looking for signs that the economy will temper its growth just enough to allow policy makers to ease off on their monetary tightening campaign.
The market is comfortable with the weakness in the transport sector because that historically has been a leading indicator of turns in the business cycle, said Anthony Chan, chief economist at JPMorgan Private Client Services.
The Dow Jones Transport index, a benchmark that includes trucking, railroad, airline and parcel-delivery companies, has lost nearly 12 percent in four straight weeks of declines after reaching a lifetime high in mid-May.
While several companies within the index have delivered strong earnings in the latest quarter, including AMR Corp., Continental Airlines Inc. and FedEx Corp., investors in transport stocks may be paying more attention to economic indicators than the earnings reports of individual companies.
If economy slows, there's fewer goods being shipped around, said Barry Hyman, equity market strategist, EKN Financial Services Inc. in New York. We've seen serious deterioration in prices of some of these companies and they are indicative of an economy that is going to slow.
That sentiment was underscored on Tuesday when the chief financial officer of United Parcel Service Inc., Scott Davis, said the world's No. 1 package delivery service sees a lot of signs the economy is moderating.
UPS stock fell more than 10 percent following the remarks, and dragged down shares of some of its rivals, but the three major stock indexes all ended the day higher.
The broader market didn't sink along with UPS because signs of a soft landing are exactly what stock investors are looking for to put the Fed's mind at ease.
The slowdown is not seemingly worse than expected and that will prevent any further market deterioration, especially when earnings are good, Hyman said. There's still more left in this rally.
If anything, Davis' remarks may have helped the major indexes after he added, We don't expect a real bad economy.
By the time UPS reported, it appeared that investors had already made up their minds about prospects for the economy and the transportation sector.
Logistics and truck leasing company Ryder System Inc. and Burlington Northern Santa Fe Corp., the No. 2 U.S. railroad operator, both beat expectations, but both stocks were punished for the gloomy outlooks of their rivals.
Trucker YRC Worldwide Inc., formerly known as Yellow Roadway, on Thursday reported quarterly profit that beat Wall Street forecasts, and it gave a full-year outlook that was higher than expected. Nevertheless, the shares on Friday fell 2 percent to $40.84 on the NYSE.
When you saw Yellow providing decent guidance, guess what, nobody believed them. That's adding further excitement to theory that the economy is slowing down, said JPMorgan's Chan.
If investors get what they want and the economy makes a gentle landing, allowing the Fed to stop the rate hikes, transportation stocks don't necessarily have to lag the major indexes.
If you think that you're going to have a moderate inflation and a moderate slowdown in growth, staples, health-care and insurance names within financials will be the outperformers, said Scott Wren, senior equity strategist at A.G. Edwards & Sons Inc. in New York. Through the end of the year, you do have a good shot of overall transports being in line with the market. We can do OK in a moderate inflation environment.