Look to This Stock for Clues About the Economy

Can you name the oldest stock index still in use? Here’s a clue: it’s even older than the Dow Jones Industrial Average (DJIA).

Ten points if you guessed the Dow Jones Transportation Average (also known as the Dow Transports). Charles Dow dreamed up the index nearly 130 years ago, as he presumed that the share price movements of transportation-related companies would provide a clear read on the amount of goods being sold (and trafficked) across the country.

(As a side note, Dow also noted the importance of the Dow Transports and the DJIA moving in tandem. If only one was rallying, you shouldn’t trust it. This is one of the six tenets of the Dow Theory, which is best left for another day).

Had Dow been around today, he might have stopped focusing on the Dow Transports and simply watched FedEx (NYSE: FDX), the world’s largest shipper. As you look at FedEx’s stock chart in the last year, you can get a clear read on investor expectations about the economy.

Shares rallied nicely into the spring, just as investors came to assume that the economic rebound would be sustainable. A sharp slump in FedEx shares into early July mirrored the increasing bearishness among investors for the economy and corporate profits. The fact that shares have since surged +20% tells you everything you need to know about the most recent investor outlook for the economy.

A healthy pause
After that recent run, shares are pulling back -3% on Thursday as FedEx released generally solid quarterly results and boosted its outlook above the consensus. Don’t let the pullback scare you — it happens every quarter. Investors buy shares ahead of earnings and always seem to take profits when results are announced. That’s because management is usually very cautious in its financial assessments, which can temporarily spook investors. And they did it again. “We are expecting a phase of somewhat slower growth going forward,” said the company’s Chairman Fred Smith on the quarterly conference call.

#-ad_banner-#And that’s just fine. Demand for shipping has already rebounded sharply from the depths of the recession (FedEx’s sales were up +18% from last year), and the simple fact that the company sees growth ahead is the main takeaway. Only recently, many investors had been fretting that the economy may be heading back into recession. At this point, even slow growth creates a more welcome backdrop for investors, which explains why the stock market — and FedEx — have been rallying in recent weeks.

Action to Take –> This is not to say that shares of FedEx are a buy. Shares appear fairly valued at around 16 times projected fiscal (May) 2011 profits. It’s hard to argue that shares deserve a higher multiple when growth is likely to be just OK for at least the next year. And that might also imply only moderate upside for the broader stock market in the months ahead as well. That’s why it’s so important to be a stock-picker in this market environment.

Investors looking at transport stocks should check out Arkansas Best (Nasdaq: ABFS), which is poised to pick up market share from distressed rival YRC Worldwide (Nasdaq: YRCW). I looked at the shipper back in June in a profile of companies benefiting from rivals’ woes. [Read more]

Results are likely to be lackluster for the rest of the this year, but should be improving into 2011 thanks to recent streamlining efforts, expected pension reform and slightly higher shipping volume coupled with firmer pricing. Right now, shares of Arkansas Best trade for about four times consensus 2011 EBITDA forecasts.