Transport Drama Revs Up

FedEx is the latest 'negative divergence' in the Dow industrials' run to all-time highs.
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This week may have brought the year's busiest shipping days for

FedEx

(FDX) - Get Report

and

UPS

(UPS) - Get Report

, but the good news stops there. Transportation stocks are troubled.

FedEx posted an 8.5% increase in second-quarter earnings, but investors sold the stock on the company's third-quarter earnings guidance, which fell short of expectations. FedEx CEO and President Frederick W. Smith said the company expects "somewhat slower" growth in the second half of its fiscal year, but highlighted strength in its Asia operations and a decent holiday shopping season. But the damage was done: "FedEx expects slower growth" is what the market heard, and the ramifications of that statement can run far and wide.

Shares of FedEx slipped 1.9% Wednesday, while UPS fell 1.3% and the Dow Jones Transportation Average fell 1.14%. Meanwhile, the

Dow Jones Industrial Average

hit an all-time intraday high of 14,498.47, but missed making yet another closing high, finishing down 0.06% to 12,463.87. The

S&P 500

fell 0.1% to close at 1423.53, and the

Nasdaq Composite

fell 0.08% to close at 2427.61.

The Dow just missed another all-time high and finished down a hair. So why are market professionals concerned about Wednesday's action?

Dow Theory suggests that the Dow Jones Industrial and the Dow Jones Transportation Averages should be moving in the same direction to confirm a trend. If they are moving in opposite directions, investors take heed, and worry that the divergence means the market can't sustain its current trend. Well, take notice.

While both Dow averages were in the red Wednesday, they have been moving apart lately. While the DJIA has made 21 new all-time closing highs since October, the Transports have had a rougher go. The Transports made an all-time high on May 9, hit a low for the year in August, and have spent the ensuing months nicking and fighting with the DJIA. Since mid-November, the Transports have been in a downward trend as the DJIA keeps breaking records.

What gives? The notion that the Transports would confirm the DJIA rally makes sense because a relatively strong economy that boosts these large industrial companies typically means they are making, selling and

shipping

more products. This could be a case of overheated expectations.

All the hoopla and relief about a so-called soft landing for the economy ignores the impact of the slowdown on these companies, however soft it may be. UPS has been cutting costs of late, announcing earlier this month another 650 job cuts atop its prior plans to slash its staff by 1,200. But FedEx and UPS aren't the only companies worried about a slowing economy. Somewhat lost in the shuffle lately have been several reports of poor growth and weak demand by trucking companies, and slowing rail shipments.

The trucking industry has reported weak demand recently, lamenting that the typical pre-holiday peak didn't appear this year. Just last week, trucking companies

YRC Worldwide

(YRCW) - Get Report

and

USA Truck

(USAK) - Get Report

reported dismal profit outlooks.

YRC and USA Truck each rose modestly Wednesday, but other economically sensitive names such as

Alcoa

(AA) - Get Report

and

Newmont Mining

(NEM) - Get Report

finished in the red. Also,

Freeport McMoran Copper & Gold

(NEM) - Get Report

slid 2.8% as the price of copper fell 1.7% to close under $3 per pound at $2.96 per pound. The Philadelphia Stock Exchange Gold & Silver Index fell 2.1%

Energy stocks fell even as oil rose 0.4% to close at $63.72 per barrel, a 14-week high. But crude futures reached an intraday high of $64.15, a level that gets stock investors nervous about economic growth.

Exxon Mobil

(XOM) - Get Report

,

Chevron

(CVX) - Get Report

and

BP

(BP) - Get Report

each dropped more than 1%. The Amex Oil Index lost 1.1%.

But the recent contraction in transports and other deep cyclical names doesn't mean the sky is falling.

"The recent slowdown in shipments is indicative of excessive inventories that built up over the summer," says John Lonski, chief economist at Moody's Investors Service. "This is still consistent with the soft landing."

Companies had too much inventory so they cut back on orders and shipments, which can be a temporary adjustment. The country is also witnessing a slowdown in production, which is another way companies are attempting to reduce excess inventories. Friday's report of businesses' new durable goods orders could again reflect that inventories are still ahead of sales, says Lonski. The consensus expects a 1.5% increase in durable goods orders, but Lonski believes the number may come in under those estimates.

"This is important, and worth noting, but November's better-than-expected retail sales is also important," says Lonski. As long as consumer spending remains robust, the decline in shipping demand could be a hiccup in the economic Goldilocks tale. Only if demand isn't strong enough to improve the balance between businesses' inventories and sales, "slippage in freight volumes might be one of many developments that point to a slower economy," he says.

So, weakness in the Transports average may likewise be short-lived.

"There is nothing in the Dow Theory that says which average has to go to a new high first," says Louise Yamada, of Louise Yamada Technical Research Advisors, who notes the market is not showing many bearish divergences. The ratio of new highs vs. new lows matched a 2005 peak last week, which was "nice confirmation of the new highs," Yamada says, adding that the total volume of buying also has confirmed the rally.

But the veteran technician notes many stocks are starting to "digest their gains," and it wouldn't be surprising to see the market consolidate in the near future. She shies away from tagging any small declines as tops, because most stocks, including FedEx, she says, are still in an uptrend.

In sum, the Transports and the inventories are worth watching, but not worth panicking over.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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