The Transports are an important index I use for deeper market research and trading opportunities. There are couple important occurrences taking place on the long-term price chart that are worth mentioning at this stage of the overall bull market.

In 2015, the Transports peaked out at 9,300 while hitting an RSI on the monthly chart of 86. This was the highest reading in the history of the index. See point 1 on the chart below. These extreme readings are the first warning we have for the longer term index performance because they suggest a peak in euphoria has been reached for the cycle. Following the 2015-2106 correction, which took the index down to 6,400, the market made another charge at the highs, besting 2015’s price by hitting 9,600. However, this time as we can see below at point 2, the monthly RSI hasn’t even broken 70. This monthly divergence was last seen in 2007 and 1998.

Chart 1: Dow Jones Transportation Index 1980-2017 Monthly

Chart 2 zooms in on these three instances a bit closer. Note that each rally to higher highs late in the cycle resulted in RSI readings below 70. In fact, it is one of the weakest secondary readings of the three prior instances. This overall divergence is something to be aware of, and for Fusion Point members, we’ve already bought and sold numerous sub indexes and stocks since last year. Please see the DAL Buy Setup and the Airline Fade Trade. We’ve been able to effectively use these longer term charts to not only catch the rally but sell the top. Having traded through numerous longer term cycles, I am well aware that even if a top has been forming, it doesn’t happen overnight and/or in a straight line. The volatility in Transports has created fantastic opportunities for active traders.

Chart 2: Dow Jones Transportation Index 1994-2017 Monthly

But it isn’t just a technical concern overriding the overall space. Although at this stage of the bull market the following won’t surprise anyone, I thought it would be worthwhile to take a look under the hood at some of the more important names. The first chart pulls the iShares Transportation Average ETF (NYSEARCA:IYT). It’s important as with all indexes to be aware of weightings and calculations. These are the top 10 holdings by weight. You can clearly see that FedEx (NYSE:FDX), Norfolk Southern (NYSE:NSC), and Union Pacific (NYSE:UNP) play an important role as combined they comprise 25% of the ETF.

I’ve taken the liberty of making my own adjustments to the above list before looking at the valuations. The following chart takes the top names, throws out Kirby Corp. (NYSE:KEX) and Ryder System (NYSE:R), and instead adds Delta Air Lines (NYSE:DAL) and Southwest Airlines (NYSE:LUV). This helps get a better look at airlines in terms of representation and ultimately these are the stocks I care about. Let’s look at valuations (source: Finviz):

A few things should jump out from the above chart. First, some of the largest components are all trading +20X TTM and in United Parcel’s (NYSE:UPS) case a PEG of +3. Second, the airlines clearly look cheap, and third, the dividend yields are fairly wide in terms of differences. Although outside the scope of this article, I will first say the airline valuations can be explained by three forces worth a deeper dive. Operating margins, revenue, and average ticket prices are all in year-over-year declines. With that out of the way, here’s how I shape up the above from a higher level view.

The following is analysis designed to keep a broad view of the space and make general conclusions. It should be understood there are deep differences in individual sub indexes (rails, autos, planes, ships, etc.) and especially stocks. We’ve traded every direction on these, and DAL last summer prior to the rally (2016), I don’t think gets much cheaper. This was confirmed by Buffett taking positions across the sector.

But here we sit almost 10 months later, and so here is how I run the numbers based off equity risk premiums.

I first take the inverse PE of each stock in the above by weight. That gives us an idea of yield on the index or ETF. In this case, the weighted inverse PE is trading at 3.2%. That is the earnings yield for the stocks that matter in Transports. The second adjustment is to run the same for the dividend yield. In this case, the weighted dividend is just under 1%. So, effectively, investors are getting 4.2% to hold the transports, or in other words, maybe 2.2% over the long-term treasury (RFR). Anyone whose been a longer term investor knows these odds are not fantastic for participants here, especially for cyclicals.

The third and final chart shows the Airline and Railroad sub indexes as technically they appear the most challenged. I’ve also added a macro component, a chart of industrial production. Note that at all other tops industrial production had already rolled over. Although the production numbers have leveled off, one of my bigger concerns has been watching transport stocks move higher without a real bounce in production. Further, the technical divergence now on the long-term charts while this condition is in place only increases the overall caution levels.

Chart 3: Dow Jones Transportation Index and Sub Indexes

In summary, Transports will continue to be a big focus of mine over the next 12+ months. Fundamentally, the ERPs (equity risk premiums) on the index and ETF are minimal in the bigger picture, and as of this writing, the longer term technicals are flashing important warnings.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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