Slumping Transports Could Signal Broad-Based Decline

Transportation stocks reflect the strength and weakness of the U.S. economic engine, with sector price action having the power to reliably predict broader market direction. For that reason, technicians are sitting up and taking notice because the Dow Jones Transportation Average (DJTA) is sharply diverging from the S&P 500 Index, carving a much weaker price pattern that could signal a broad-based decline in the second quarter.

The S&P 500 has retraced nearly 80% of the fourth quarter sell-off, while the DJTA has retraced just 50%. In addition, the average is now trading below the 50- and 200-day exponential moving averages (EMAs) after testing those support levels for two months, unlike the blue-chip index, which is holding well above those moving averages. And ominously, the transportation sector fund shows an aggressive exodus that has reached mid-2017 levels, warning that institutions are abandoning long positions in the 10th year of an economic expansion.

The iShares Dow Jones Transportation Average Index Fund ETF (IYT) broke out above the 2008 high at $99.09 in 2013, entering a powerful uptrend that stalled near $168 in December 2014. It sold off into the first quarter of 2016 before finding support at a two-year low near $120, setting the stage for a dramatic recovery wave that cleared 2015 resistance in October 2017. The fund powered to a new high at $207 in January 2018 and reversed at that level in September, completing a small-scale head and shoulders breakdown three months later.

It bounced at a two-year low in the $150s at year end and ticked higher into February, stalling above the .618 Fibonacci sell-off retracement level and drifting lower through March. It has now reached horizontal support at $180, while the on-balance volume (OBV) accumulation-distribution indicator has dropped to the lowest low since May 2017, when the fund was trading more than 25 points lower. In turn, this divergence predicts a breakdown that could test the 2018 low.

The thinly traded US Global Jets ETF (JETS) could offer clues about sector direction in the coming weeks because commercial airlines are stuck in the lower half of the average's component performance list, with American Airlines Group Inc. (AAL) taking the 19th slot, just one click higher than bottom-dwelling FedEx Corporation (FDX). Worse yet, airlines comprise six of the bottom nine positions, signaling laggard action consistent with emerging downtrends.

The fund came public in the mid-$20s in 2015 and traded in a tight range until a 2016 breakout that posted an all-time high at $34.75 in January 2018. It has carved a long series of lower highs and lower lows since that time and is now losing ground after reversing above the 50- and 200-day EMAs in early March. A test at the December low looks inevitable, with a breakdown through the 50% retracement of the 2016 into 2018 uptrend triggering more aggressive selling pressure.

Former market leader FedEx Corporation (FDX) has weighed heavily on the sector since December, when it broke down from a two-month declining channel and dumped vertically to a two-year low near $150. It filled the December gap into early February and reversed at 50-day EMA resistance, carving bearish action that is consistent with an active downtrend. The stock has been drifting lower for the past six weeks, setting the stage for a test at the 2018 low.

OBV confirms the broken long-term uptrend, posting an all-time high in June 2018 and entering a modest distribution phase that escalated into a near-panic into December's 19-month low. The indicator bounced into February and has now resumed its southward trajectory, nearing a key support test. A breakdown would raise the odds that aggressive selling pressure continues into the 2016 low near $120.

The Dow Jones Transportation Average could turn sharply lower in the coming weeks, raising the odds that broad-based indices could reverse and follow suit.

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