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Proof That the Transport Industry Doesn't Always Lead the Way

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The transportation index is rarely a good predictor in the short run of what is going to happen to the market in the longer run. Here's why.

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There was some stir in the market last week about the performance of the transport stocks. Many analysts believe that the transport industry leads the way in all rallies and all declining markets. The rationale is simple: Makers of products need to have raw goods shipped to them, and then, in turn, ship their products. So, when future demand is good or weak, the results for these firms tend to forecast the coming change for other companies down the line.

The argument makes some sense, and it is so simple and straightforward that it's hard to disagree with as in most rallies and declines, the transport indexes have been highly correlated with the broader markets.

But I am here to argue against this idea today. I believe that you shouldn't try to time this market – and the transport pullback is just an excuse to try to do just that. I am confident that this market will continue to climb upward -- more than likely on a zigzag pattern for the next year to come but generally with an upward slope.

The reasons I won't let the transport price performance last week scare me away? First, the pullback is just five days worth of data. This is just not enough data to base a portfolio-adjusting decision on. Second, I found conflicting data among three different transport indexes last week: one was flat for the week, one was down 2%, and one was down 3.5%. The Nasdaq Transportation Index was flat while the Dow Jones was down 2%.

Overall, the transports have participated in this rally, so a minor pullback in this sector on a week when the market pulled back slightly is not abnormal. However, if the market continues to march upward and transports pause or retract, then I might ask a lot more questions around this trend. Maybe it would just signal a buying opportunity in transports – or it might signal a real shift that we need to watch.

Transports rarely predict a market change

Being doubtful of the claim that the transport sector leads the way for the future market values, my firm decided to run a simple data comparison. We looked at the Nasdaq Transportation Index performance over the last 12 years – since January 3, 2000. We examined every 20-day market window. If the Index deviated in performance from the S&P 500 by 5%, we examined the subsequent six-month broad market performance. The deviation could be positive (indicating future market promise) or negative (predicting future market malaise). The deviation had to be at least 5% -- negative or positive.

In addition, we looked at unique circumstances of deviation only – meaning that if the 20-day performance finishing on April 2 was more than 5% deviation and the 20-day window finishing on April 3 was also more than 5%, we considered that to be one event. In other words, subsequent expiration days for the 20-day window that were over 5% deviation were considered one event. There had to be a break with a day that finished the 20-day window without a 5% deviation to be considered a change.

Then, for each of these events, we looked at the market performance in the subsequent six-month window for the S&P 500. In other words, did the deviation in the transportation index predict the proper direction for the market for the subsequent six months? If the transportation index outperformed the S&P 500 in the 20-day window, then we looked for a positive market result. If it underperformed the S&P 500 for the 20-day window, then we expected the market results to be negative for the six months to follow.

The results were mixed at best. We counted 144 unique events where the 20-day NasdaqTransportation Index deviated by more than 5% from the S&P 500 index. Of those 144 events, 70 times the market (S&P 500) moved in the direction predicted by the outperformance or underperformance of the transportation index. Of course, that means that the broad market moved in the opposite direction that the transportation index predicted 74 times.

Digging deeper, we found that of the 70 times that the market moved as the transportation index predicted, the index had outperformed in the 20-day window 42 times – versus 28 times where the index underperformed. Of the 74 times the index was wrong, the index indicator for the 20-day window outperformed 49 times and underperformed 25 times. So, you can see, even when split by the indicator, it is still very close to 50/50 (ie, 42 vs. 49 and 28 vs. 25).

I decided to dig a little deeper and see if there was a difference between the data pre-2008 and post-2008. But it didn't make a difference. There were 91 events where the transportation index deviated by more than 5% prior to 2008 – and 45 of them gave off the wrong indicator. The other 46 were right in their direction. So, the post-2008 were also about 50/50 with a split of 29 wrong and 24 correct.

The net/net here for me is simple: The transportation index is rarely a good predictor in the short run of what is going to happen to the market in the longer run. Instead, stick to the fundamentals of the market and don't try to time it!

Editor's Note: For more from Wayne Ferbert, go to Buy & Hedge ETF Strategies.
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No positions in stocks mentioned.
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