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Why investors watch for U.S. transport signals

In this April 25, 2011 photo, United Parcel Service (UPS) driver Albert Palafox finishes his deliveries in Palo Alto, Calif. UPS lowered its earnings expectations for the year on Tuesday as economic weakness and uncertainty persist around the globe. The world's largest package delivery company said its customers are worried about the global economy weakening in the second half of the year.

Paul Sakuma/AP

United Parcel Service Inc.'s disappointing profit results, which came with a reduced outlook for 2012 earnings, are providing another unwelcome sign of a weakening global economy.

As a major constituent of the Dow Jones Transportation Average, the delivery company's stock performance has broader implications for traders and investors who use "the trannies" as a leading market indicator.

These stocks are keenly sensitive to U.S. and global economic performance. UPS generates 26 per cent of its revenue outside the United States and slowing global business activity immediately shows up in its earnings.

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The global transportation market is worth watching for Canadian investors, too. There's normally a close correlation between the DJ Transportation Average and the S&P/TSX composite index, where commodity stocks reflect global manufacturing activity.

More recently, that correlation has broken down. The Transports have moved higher and the S&P/TSX has drifted sideways (see chart at left). Domestic investors hope the divergence will be corrected by a rise in the TSX. But the UPS results suggest that if the two indexes are going to start moving in tandem again, it will be with a decline in transport stocks.

UPS is only one company in an index with 30 members, so Tuesday's disappointment does not represent a definitive sign that the Dow transports will continue lower. The next signal for the sector will come Wednesday from Canadian Pacific Railway and Canadian National Railway. The Canadian rails' financial results will hint at activity levels for index members Union Pacific Corp, Kansas City Southern and Norfolk Southern.

Weaker than expected profits for the railways will confirm the UPS trend, and the Transports will continue to decline. Positive earnings surprises will increase the odds of a S&P/TSX rally.

The Dow Jones Transportation Index is just one indicator among many. But its extremely close relationship with the S&P/TSX suggests Canadian investors would do well to recognize that diverging performance with these two benchmarks can signal a change in direction for our domestic equity market.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

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