A century-old market timing strategy known as Dow Theory views the rally in airline stocks as a bullish sign, but investors need to approach the transportation sector with skepticism.
High oil prices. Fee-weary passengers. A global economy that’s still not firing on all cylinders. And geopolitical crises forcing carriers to re-route their flights.
Given these recent developments, you’d think that airlines stocks would be struggling of late.
But you’d be wrong. Airline stocks have been among the best performing groups in the U.S. stock market recently, with the Dow Jones U.S. airline index up nearly 75% over the past 12 months.
In the short run, this trend is likely to continue, especially if airlines keep posting strong results. On Tuesday, Delta Airlines reported that revenue grew more than 9% in the recently ended quarter, versus the same period last year. The carrier also reported earnings per share of $1.04, versus consensus forecasts of around $1.02 a share.
But what of the long run?
One of the most enduring market-timing strategies on Wall Street would seem to point to blue skies ahead—and not just for airline and transportation stocks.
Dow Theory, the brainchild of Charles Dow, the founder of The Wall Street Journal, is one of the oldest technical indicators that’s still used by investors to gauge future stock market movements. Dow Theory has many technical layers, but in broad strokes the strategy seeks to verify trends in the Dow Jones Industrial Average by looking at the Dow Jones Transportation Average.
The idea is that stocks tend to rise when the economy is humming. And to tell if that’s the case, you need to see not only that factories are on the upswing (as measured by the Dow Industrials), but that transportation companies that are paid to move manufactured goods out of those factories are also on a roll. Hence the need to study the Dow Transports.
Recently, the airlines haven’t been the only transports rallying. Shares of railroads and trucking-related companies have also been on the rise:
This explains why both the Dow Industrials and Dow Transports are at or really close to their all-time highs:
Still, it’s important to understand that transport stocks have been soaring for more than five years now, as investors have been anticipating an improved economy ever since 2009.
The result is the bull market in transportation is getting long in the tooth. Meanwhile, valuations for many of these companies, including the airlines, are soaring.
As you can see below, while the broad market trades at a price/earnings ratio of around 17 or 18, many airline stocks — such as Southwest , United Continental , JetBlue , and Spirit — trade at significantly higher P/E ratios.
The bottom line: This may be a time when it makes more sense to look at the fundamentals of each individual company, rather than at the technical trends for the airlines or transports as a whole.