The Dow Jones Transportation Average has been on a tear since the October 2002 low. Despite the bankruptcy problems of the commuter airlines, other transportation stocks such as the truckers, railroads and air freight have lead the industrial stocks higher. However, if transportation stocks continue to drive higher, they could overheat and find themselves headed straight off of a steep cliff.
I’ve often used the overlay of the Dow Jones Industrials during their blow off run in 1987 to predict market movements. Similar exercises were very successful with the homebuilders but very unsuccessful with the energy stocks.
The Dow Jones Transportation Average now seems to be mimicking the Industrials move from 1984 to 1987.
Overlay analysis works best when it is corroborated by other factors such as valuations and fundamentals. It’s difficult to find historical valuation data on the Dow Jones Transports. The earnings are much too cyclical to be meaningful because the Dow Jones Transport Average contains several airline stocks. However, based on the dividend yield and book value, the Transports are trading at the high end of their historical range.
Source: Baseline
Several of the Transport component sectors are also trading at the higher end of their historical range. The truckers, airfreight and railroads are all trading toward the upper end of their price to sales and price to book values.
Source: Baseline
But despite the high valuations, the fundamentals for the group remain strong. Earnings estimates for 2006 have continued to rise steadily and are now being buoyed by the rebounding airlines.
Source: Baseline
While valuations are high, they aren’t completely out of line if earnings continue to increase. However, if price continues higher at it’s torrid pace, I’ll become extremely cautious on the transportation sector because it would be highly probable that the stocks have entered a blow off phase similar to the Dow Jones Industrials during July and August of 1987.