The link between the Dow Jones Transportation Average and the more-familiar Dow Jones Industrial Average is as old as the hills. If the indices are moving higher in tandem, the U.S. economy is perceived to be doing well because industry is making and transports are taking. However, should the transports start falling, especially ahead of similar moves in the industrial average, then the perception is that the economy is slowing because shipping demand, historically a leading economic indicator, has softened.
The correlation isn’t as strong as it used to be. Transportation is nowhere near as dominant as when the 20-stock index was formed in 1884 and railroads were arguably the country’s most important industry. The 30-stock industrial average, which came into being 12 years later, today includes tech companies and retailers that would not be associated with the businesses that made up the average for most of its history.
Yet the connection still exists. The Dow Theory, which predicts overall market trends depending on whether the two indices confirm upward moves or if they diverge, is used by some traders to divine shifts in market cycles. Freight recessions have in the past preceded broad economic downturns, the idea being that weakening shipping demand telegraphs a slowdown in ordering and production activity.
According to the DowTheory newsletter, which has tracked the correlation for decades, the transports made their last high on Nov. 2. The industrial average and the Standard & Poor’s 500 made their respective highs on Jan. 3 and 4. However, according to the newsletter, the transport average did not confirm the other two high-water marks, thus raising a red flag. The subsequent action in the indices, according to the newsletter, triggered a sell signal on Feb. 22, two days before Russia invaded Ukraine.
The signal was prescient. Over the last eight trading days, the transport average endured one of the worst periods in its history. Through Friday, the average dropped more than 2,300 points, a decline of 13%. It rebounded slightly on Thursday only to fall anew on Friday. Not since the spring of 2020 when the COVID-19 pandemic shut down much of the U.S. economy has the carnage been this severe. It didn’t help that Ken Hoexter, the long-time Bank of America Securities transport analyst, on Friday downgraded nine of the 28 stocks in his coverage universe.
The downward move was not lost on the mainstream business and financial media. On Tuesday, veteran columnist Mark Hulbert wrote on the financial platform MarketWatch that the transports are “in a ditch. Can the stock market and the economy be far behind?” The next day, Al Root, a columnist for the financial publication Barron’s and who has a solid grasp of the industry, wrote that “another recession indicator just flashed red.”
But will the transports be such a reliable indicator this time around, especially in light of what the U.S. and global economies have been through since April 2020? There has been nothing normal about the past two years. Domestic demand spiked to unprecedented levels and only recently has begun to ease. This has led to the strongest trucking market in three decades. Conversely, the second half of March, which has always been one of the trucking industry’s strongest periods, has seen weakness in almost every demand metric.
A school of thought is that transportation is in the process of a massive reversion to the mean that could take demand trendlines back to pre-COVID levels. Fiscal stimulus is waning. Consumer spending is titling more toward services, especially as warmer weather beckons. Retailers that stuffed their warehouses with inventory to protect against supply chain disruptions may not need to reorder anytime soon. Markets have begun to discount these events by hammering the shares of truckload carriers, parcel carriers and anyone else that makes a living transporting retail freight.
By contrast, flatbed demand and pricing, both of which reflect the state of industrial activity, continue to plug along at a healthy clip. Jason Miller, associate professor of logistics at Michigan State University’s Eli Broad College of Business, said that February machinery production, on a seasonally adjusted basis, surpassed the prior production peak of late 2018. Farmers buoyed by strong cash prices for commodities like corn, wheat and soybeans are buying equipment. Add to that the new $1.2 trillion infrastructure spending package and a continued rise in housing starts, and there is every indication that demand for flatbed services should stay strong for months, he said.
The current downturn in the transport average signals more of a return to long-term trends rather than an impending recession, according to Miller. He pointed to data from the Chicago Federal Reserve showing a steep drop in March inflation-adjusted sales retail trade and food service sales, excluding motor vehicle and parts dealers. However, the decline represents a return to the pre-COVID trendline of January 2019 through February 2020, he said.
Miller said consumer spending has been so elevated since the last federal stimulus package hit bank accounts in March 2021 that it was just a matter of time before demand cooled. “The key thing is that declining spot prices for the dry van sector suggest the ability of truckload carriers to command further pricing increases will diminish, which is why their shares have been hit.”
Jason H. Seidl, transport analyst for Cowen & Co., said numerous cross-currents are buffeting transportation shares. Higher inflation is pinching consumers and may lead to demand destruction. Services are increasingly competing with goods for consumer dollars. Spot market prices have come off their peaks. Trucking seasonality is anything but, with weakness emerging in what is normally a very strong time of year. Flatbed demand and pricing remain firm, he said.
In a Wednesday note, Seidl said that trucking and logistics executives have told him that waning truckload demand has driven up primary acceptance rates of tenders and lowered trucker costs per mile. Driver recruitment has gotten easier as more people return to work, though equipment shortages remain an issue, Seidl said he was told. A large shipper that Seidl did not identify said that 30% of its freight is moving in the spot market compared to last year when all its business was under contract.
Though the truckload contract market hasn’t yet turned south, the softness in spot rates, which typically lead contract moves by three to six months, make a downturn in contract pricing very likely, Seidl said. A brokerage executive said the company is seeing record gross profit margins per load as margins remain high while rates fall.
Anecdotes aside, Seidl said in an interview on Tuesday there wasn’t enough April data to get clarity on where the market was going. It will take at least until the middle of the month for data points to guide him on future trends.