Drop in Transportation Stocks Foreshadows Weakening Economy

Date: Friday, April 21, 2023
Source: Wall Street Journal

Economically sensitive stocks, like those of transportation and small-cap companies, are trailing the broader market, reflecting growing investor concern about a potential recession.

The Dow Jones Transportation Average, which tracks 20 large U.S. companies ranging from airlines to railroads to truckers, has underperformed the Dow Jones Industrial Average by about 6.9 percentage points since early February. Shares of Norfolk Southern Corp., American Airlines Group Inc. and J.B. Hunt Transport Services Inc. have dropped at least 8.5% over the same period.

Small-cap stocks, often perceived as riskier and more sensitive to economic changes than their larger peers, have also fallen behind in recent weeks after rallying to kick off the year. The S&P Small Cap 600 Index has edged up 0.5% in 2023, trailing the S&P 500’s 7.6% advance.

Historically, transportation and small-cap stocks have led in market recoveries but also sold off faster during periods of economic downturns when demand for goods, materials and travel slow.

“Transportation investors are taking a negative view of the economy, and I think ultimately they will be proved right,” said Mahmood Noorani, chief executive and founder of Quant Insight, a data and analytics provider.

Recession fears have intensified recently. Last month’s sudden collapse of Silicon Valley Bank and the stress at regional banks spurred worries about potential strains in bank lending and the willingness of businesses to hire and households to spend. Economists surveyed by The Wall Street Journal put the probability of a recession at some point in the next 12 months at 61%, though they expect a shallow and short-lived economic contraction.

Some company-specific news is also to blame for the recent slide in the stocks.

Norfolk Southern was sued by federal prosecutors and environmental regulators after one of its trains derailed in February, releasing hazardous chemicals in East Palestine, Ohio. The company has said it would spend whatever it takes to reimburse residents and clean up the town.

Last week, American Airlines guided expectations lower for the first quarter, while Delta Air Lines Inc. reported a quarterly loss and said consumers’ behavior has been shifting in ways that can be difficult for airlines to predict. The U.S. Global Jets ETF, an exchange-traded fund tracking the airline industry’s performance, has fallen 1.6% this month.

“There are concerns about the recession, volatile oil prices, and this is as good as it gets from a demand perspective,” said Helane Becker, an airline analyst with investment bank Cowen.

Trucking and logistics company J.B. Hunt, a bellwether for the freight market, said Monday that its profit and revenue for the latest quarter declined more than expected in what the company called a “freight recession.”

“To start, we’re in a challenging freight environment where there is deflationary price pressure for an industry that continues to face inflationary cost pressures,” J.B. Hunt President Shelley Simpson said on a conference call.

Meanwhile, rising crude-oil prices have dented the profits of transportation companies and other big fuel consumers. Global oil prices have rallied above $80 a barrel recently, hitting their highest level of the year.

Although the recent decline in transportation stocks portends a weakening U.S. economy, some investors and analysts challenge the notion that a recession is around the corner. That is largely because the labor market and consumer spending have remained resilient thus far.

Others say the market is sending mixed signals.

The yield on the 10-year Treasury note, which affects everything from auto and student loans to mortgage debt, has dropped to 3.546% from above 4% in early March. The yield on the two-year note, which reflects investor expectations for short-term interest rates, has fallen to 4.170%, down from a 15-year high of 5.064% last month on hopes the Federal Reserve is nearing the end of its bid to raise interest rates.

Lower yields have encouraged some investors to rotate back into big tech stocks. When yields fall, they are often more willing to pay up for shares of companies that they expect to generate outsize profits in the future. The Nasdaq Composite Index has climbed 15% this year, including 3.3% in the past month, outperforming the other major indexes.

Even if the economy tips into a recession, investors have had enough time to stress test against the scenario, said Diane Jaffee, lead portfolio manager for the relative value group at TCW.

“This recession has been the most talked about recession in my investment career,” Ms. Jaffee said. “I think companies and portfolio managers are really well prepared for it, but that doesn’t mean it won’t happen. It just means that you have to be very selective in terms of the stocks that you are choosing.”

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