The Dow Transports correction is partly a function of valuation
The recent correction in transports has to be viewed in the context of the index’s 120 percent advance from its 2012 lows. According to Bloomberg data, the two years heading into the end of 2014, the Transport Index posted returns double that of the broader Industrials index. Keep in mind as well that according to Bloomberg data, Transports outperformed by a wide margin during 2014 thanks to several factors: continued growth in e-commerce, lower oil prices benefiting airline earnings and expected crude-by-rail volume growth. This year, the bottoming in oil prices, weak natural gas prices (which reduces demand for coal shipments), declining trade volumes and lackluster consumer spending have brought Transports valuations back down to earth.
Market Realist: Higher valuations, a stronger dollar, and relatively higher oil prices have led to a correction in transportation stocks.
Another reason why the Dow Theory may not work this time is stock valuations. Between the start of 2013 to the end of 2014, the Dow Jones Transportation Index, or DJTI, saw multiple expansions. The index rose by 72.2% during that period. In comparison, the S&P 500 (SPY)(IVV) rose by 44.4%. Meanwhile, the Dow Jones Industrial Average (DIA) rose by 36% in the same time frame.
DJTI’s PE (price-to-earnings ratio) climbed from 15.7x at the start of 2013 to 20.2x at the end of 2014. This year, transportation stocks (IYT) have taken a hit, leading to multiple contractions. The PE currently stands at 16.1x. Rich valuations is one of the reasons for the underperformance of transportation stocks.
A stronger dollar (UUP) has squeezed margins for multinational companies. Transportation stocks have been negatively affected by the lower demand that the dollar has brought about. At the same time, lower oil prices could reduce the overheads for transportation companies.