Transport stocks flag risk of a global slow puncture

Fans and detractors of this column both point out its trainspotter-ish tendencies, something that will be taken as a compliment whether it is meant as one or not. And regular readers will be very familiar with our regular looks at transportation stocks in search for signals that cut through the market noise.

Freight, shipping, truck, train and airline stocks are currently sending mixed messages. That in itself may be nothing unusual but this lack of clarity should be kept in mind at a time when equity markets are powering toward three-month highs, and in the case of the USA to within a percentage point of a new all-time peak, as this suggests stocks think everything is much more clear cut.

The picture may not be as straightforward as all that. The 30-stock Dow Jones Industrials may be better known but history shows it goes nowhere fast if the Transport index is stuck in neutral or reverse. According to Richard Russell's Dow Theory, it cannot be good news if the share prices of the firms shipping goods around America are doing worse than those of the firms making them, as this suggests business is slowing. If something is sold, it has to be shipped. If an item is left sat on a forecourt or a shelf, neither it nor new inventory need be transported.

Throughout 2015, the Dow Jones Transportation index has refused to lead – or follow – the Dow Jones Industrials higher. The only time the two really moved in lock-step was during August’s turmoil, which may not be the most encouraging precedent.

Dow Jones Transportation index is still lagging the Industrials

Source: Thomson Reuters Datastream

NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

In the UK, the FTSE All-Share Industrial Transportation index has a similar relationship with the FTSE All-Share itself. This apparent correlation broke down when Royal Mail plc was included in the sector index and promptly soared after its 2013 flotation. Yet as the excitement over the float has subsided, Royal Mail has begun to exert less influence over the sector

FTSE All-Share Industrial Transportation index is lagging the broader market

Source: Thomson Reuters Datastream

NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

It is certainly to be hoped that world trade is not slowing. Former colleagues from my days at UBS investment bank point out that world trade grew from 16.5% of global GDP in 1990 to 36.3% at the high in 2013, to account for 58.2% of the aggregate increase over the period.

A slow-down could therefore have profound implications. History suggests such a trend is capable of heralding a recession and a dash to risk-off assets. Yet with central banks more pro-active than ever, it will be interesting to see if the monetary authorities in the UK and USA keep rates lower for longer or (in the case of maybe Europe and Japan) increase the size and scope of their Quantitative Easing schemes.

If central banks do leave rates untouched in the UK and USA, or ratchet up QE schemes in Europe and Japan, that could boost risk assets by forcing cash to go looking for a return beyond the skinny offerings from cash and sovereign bonds and high-quality credit. This final chart is something that may give the US Federal Reserve pause for thought and it covers five-year forward inflation expectations in the USA.

This is not a pretty sight. Based as it is on five- and ten-year nominal and inflation-adjusted US Treasuries this suggests the market is losing faith in central banks’ ability to stoke inflation and becoming more worried about deflation, something which could have profound effects on investors’ portfolios if it does start to take hold..

Five-year inflation expectations continue to seep lower in the USA

Source: St. Louis Federal Reserve database (FRED).

NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

Russ Mould

AJ Bell Investment Director