Although the broader market is still flirting with records, the transport sector has struggled to recover lost ground—a potentially ominous sign for investors who believe transports need to rebound for the market to break higher. However, the last 10 years provide evidence that the bearish divergence between Transports and S&P500 does not necessary lead to market crashes.
Investors often look at the transport sector as a bellwether of the economy. Believers in the Dow Theory say weakness in shares of companies that transport raw goods and materials can point to turmoil for the broader market. By any measure, this expansion is old. It began in June 2009, making it the longest on record, and it shows some of the typical signs of a late-stage expansion. That doesn’t automatically mean the expansion must end, though.
Sectors including transportation and manufacturing have been sending out signals for months that a turn in the business cycle is near, leaving investors to question the longevity of one of the longest bull markets in the history of the U.S. stock market.
FedEx, for example, offered the latest signal that a turning point is coming in the business cycle during its most recent earnings announcement. The delivery company cut its 2020 outlook pointing to trade tensions and a weak global economy. More specifically, the Chief Executive Frederick Smith said on the company’s conference call that FedEx was taking steps to reduce its capacity, partly because the absence of a trade deal with China has reduced the movement of goods internationally.
So, how worried should we be about the obvious bearish divergence between the Transports and the S&P500? When we examine the relationship between the Transports and S&P500 during the last 10 years, we find that the previous two instances of similar bearish divergences (in 2012 and 2016) did not result in the bear markets. Just the opposite — after a period of “consolidation”, both indices broke out and staged 2 multi year rallies.
Transports and S&P500, Weekly
Transports continue to lag S&P500: should we be worried? The answer is — it depends what happens next. If transports break out, this bearish divergence will be invalided, just like it was invalidated in 2012 and 2016. However, if they break down, the sell off will intensify.
What can be the catalyst for a break out in 2019? We all know it: should China and the US sign a trade deal and eliminate tariffs into the year-end, this news will most likely provide enough fuel for a major break out.
Alternatively, if the parties fail to achieve long awaited trade deal, the markets will most likely sell off and a major break down will be recorded on the Transports index as well as on the S&P500.