Curve Flattening Lifts Transportation Stocks

The Dow Jones Transportation Average rallied to a five-month high this week, underpinned by bullish sentiment in reaction to COVID-19 curve-flattening across the Southern and Southwestern states. Package delivery services are leading the advance, with United Parcel Service, Inc. (UPS) surging to an all-time high. A steady airline bounce is also supporting the upside, after TSA reported the strongest air travel numbers since the pandemic began in the first quarter.

Transport price action often predicts economic strength and weakness, with shipping volumes increasing in good times and decreasing in bad times. Many truckers are now trading near new highs, highlighting the resumption of commercial and industrial activity needed to support a full recovery in 2021 and beyond. Even so, sector performance has gotten ahead of actual metrics, with many U.S. businesses reporting steep second quarter revenue declines.

Railroads are the wild cards in this equation, with Union Pacific Corporation (UNP) and CSX Corporation (CSX) now lifting toward June resistance. This transportation segment is more dependent on the energy industry than other components and will be affected if the West Texas Intermediate (WTI) crude oil futures contract rolls over in the lower $40s and heads down to levels struck during a historic decline that posted a negative number at the April low.

IYT Long-Term Chart (2003 – 2020)

The iShares Transportation Average ETF (IYT) came public in the low $50s in 2003 and entered a strong uptrend that ended near $100 in 2008. The fund fell to an all-time low during the economic collapse and turned higher into the new decade, completing a 100% retracement into the prior high in the second quarter of 2011. Price action spent the next two years completing the handle of a multi-year cup and handle pattern that broke to the upside in 2013.

The rally ended at $158 at the end of 2014, yielding a steep correction, followed by a bounce to resistance after the presidential election. An October 2017 breakout stalled at $206 in January 2018, while a failed September rally prompted a decline that posted a lower January 2020 high before breaking down to a four-year low in March. The fund remounted broken 2018 support at $155 in May and has now reached within a point of the .786 Fibonacci selloff retracement level. 

IYT Short-Term Chart (2018 – 2020)

The on-balance volume (OBV) accumulation-distribution indicator topped out in January 2018 after a long accumulation wave and reversed at that level with price in September. OBV entered an aggressive distribution phase in October, triggered by growing trade tensions with China. Selling pressure eased in June 2019, but the fund has made little progress off that depressed level in the past 14 months, raising the odds that the uptick will end at or near the .786 retracement.

Given strong resistance above $185, the majority of investors should just sit on their hands for now and watch price development. At the same time, short-term traders have the option to play specific transportation sub-sectors to take advantage of the strongest price action. Airlines show the great reward and greatest potential risk with this approach, as outlined recently in Airline Stocks Could Charge Higher in Short Covering Rally. 

The Bottom Line

The transportation average posted a five-month high this week, but heavy overhead supply could limit short-term gains.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.