Talking Numbers

This sector's strength is proof the economic recovery is on

This sector's strength is proof the economic recovery is on

For years, skeptics (and you know who you are Marc Faber, Nuorial Roubini, Peter Schiff) have disparaged the historic rally in stocks as nothing more than a Fed-induced asset bubble – the financial equivalent of Mark McGuire or Sammy Sosa. They pointed to the large buybacks and tepid topline growth as proof that the rally had been "engineered."

But railroad stocks might be throwing cold water on that theory.

The Association of American Railroads (AAR) reported an increase in rail traffic last month compared withJune 2013. "Year-over-year monthly carload growth averaged 4.9 percent from March 2014 through June 2014, the highest average for any four-month period since December 2010 through March 2011," the company said in a press release.

And, it's not just with carloads. Intermodal traffic (which uses containers that can be used on rail, shipping, or trucking) was up 6.7 percent in June compared with last year.

"What we're more impressed by is the intermodal volume," said Keith Schoonmaker, director of industrial equity research at Morningstar. He said the AAR report "reflects a healthy economy and railroads performing extremely well."

The AAR report comes along with a strong June jobs report. The unemployment rate dropped to 6.1 percent as the economy added 288,000 jobs last month.

Walter Spracklin, equity research analyst at RBC Capital Markets, said the latest rail numbers aren't too much of a departure from recent trends. He sees three factors in the latest rail growth spurt: timing, market share and the economy in general.

"Some product got held up during tough winter conditions," Spracklin said. And, "the railroad industry continues to be successful against the trucking industry."

After a painful 2.9 percent drop in the economy during the first quarter of 2014, is the AAR report the final proof that the economy is indeed turning around?

"It's certainly a good thing," said Dan Greenhaus, chief global strategist at BTIG. "The transports, generally speaking, are leveraged economic activity, as are a number of sectors of the U.S. stock market."

Transportation stocks have far outperformed broader market indices over the past year and a half. Over the last 12 months alone, the Dow Jones Transportation Average gained 30.3 percent while the Dow Jones Industrial average is up 12.4 percent.

Greenhaus said it's not just railroads that have been doing well. "The truckers have done well [and] the airlines have done well," said Greenhaus, a CNBC contributor. "We read that generally speaking as supportive of the general narrative that the economy has been improving."

For Richard Ross, global technical strategist at Auerbach Grayson, the Dow Transports' relative outperformance suggests there may be trouble ahead, based on the Dow Theory. "The industrials [are] really lagging well behind the transports," said Ross, a "Talking Numbers" contributor. "So, that's the problem I have from a Dow Theory standpoint."

Ross notes the Dow Transportation index has stayed above its 150-day moving average since the start of 2013. "Since breaking above the 150-day moving average – which we've held now for the past 18 months – you're up over 50 percent," said Ross. "Now that's a pretty big index to be up over 50 percent in just 18 months. Now of course that doesn't mean that it's going to go down from here. But I think the law of averages should take us down to that 150-day moving average."

The Dow Jones Transportation Average's 150-day moving average is currently at 7,579 while the index itself is at the 8,200 level.

"So, if you're looking to get in here, I don't think you need to chase," Ross said. "Wait for a little bit of a pullback, even though I know that strategy's been costly."

And, while, Ross sees the longer-term chart of the Dow Transports as showing strength but he still has some concerns. According to his charts, the index made a head and shoulders bottom that began in 2007, dropped to its lowest point with the financial crisis of 2009, and finally broke above its neckline in 2012 after completing its right shoulder. "That's five years, we've broken out from that," Ross said. "But I don't like that straight-lined fashion that we've taken since that breakout. I think the absence of corrective behavior has left us vulnerable here to a sharp pullback."

Should there be any hiccup in the economy, "this is where you're going to feel the pain the hardest," added Ross. "I would wait here on the transports. I like it longer term, I like it better on a pullback."

To see the full discussion on the Dow Jones Transportation Average, with Dan Greenhaus on the fundamentals and Richard Ross on the technicals, watch the above video.

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