There has been a fair bit of focus on the transportation sector of late and whether its sell off is a harbinger of economic slowdown. The theory goes that as the sector ships the goods that are then sold to companies and consumers, it is a bellwether of future spending and hence of economic growth.
The focus has been most intense in the US, where several companies have warned of a sales slowdown, especially given the strength of the dollar. The largest stocks in the sector are freight carries of different hues and hence earlier cycle than the airlines that are some of the larger companies among European names.
The chart below shows that there has been a marked fall in the valuation of the North American transport sector, but that this fall was from an extreme long term high and has done nothing other than restore the mean valuation of the industry.
Relative to the broader market however, the sector appears inexpensive and has started to bounce off a significant multi-year low.
EPS Momentum in transportation stocks is negative to the tune of a little over half a percent, but this is only slightly worse than the minus one quarter percent for the Russell 1000. Both readings are in keeping with the age old issue of overly optimistic analysts having to downgrade earnings expectations over the course of a year, triggered to do so by the realities revealed in quarterly reports.
Add the dollar strength to the picture and it is no surprise that some companies are hurting and that lower dollar oil prices are insufficient compensation for certain industries.
Implied volatility for North American transportation stocks suggests a +/- 15% move in the average sector constituent by early November, which is +/- 2% points more than for the average market constituent. It is, however, very much in the normal long term range of volatility.
If there is a warning sign, it is in relative volatility, which is at the upper reaches of the long run trend and signalling potential weakness in the sector. This measure will be one to watch carefully over the next couple of weeks, because if it declines swiftly then any panic in the sector is likely to be done and dusted with the earnings season.
What such an occurrence would then remind us is that the biggest moves in markets are being driven by relative change in monetary policy, which is first and foremost reflected in currency rates. Transportation stocks are much more exposed to the exchange rate than domestic plays and hence have suffered relatively in recent times.
Prospects of a recovery are likely to hinge on whether the Fed really does raise rates in September.
European transportation stocks have lower implied volatility than the broader market and flat EPS Momentum compared to -0.3% for the STOXX 600. While relatively cheap, the valuation discount is not as marked as in the US, lending support to the theory that it is dollar strength that is hurting US names, rather than a broader warning from transport shares about an impending slowdown in GDP.