Standing in the Vortex
David Chuhran
You need to look no further than the airlines for the primary reason the Transports failed to confirm the recent DJIA high. The airlines have been under pressure since well before 9-11 and many factors, both internal and external, have had a negative impact on the air carriers.
In addition to the two major airlines (UAL and UAIR) operating in bankruptcy protection, revenue is being influenced by many other factors, including internet pricing, inefficient hub models, the rise of the low cost carrier business model, and rising fuel prices. Ticket price increases have repeatedly failed, time after time, as one or more carriers refuse to follow the herd forcing all to withdraw their modest increases. With enhancements to the revenue side long ago exhausted, and pricing power lost, airline managements have turned their focus to attacking the cost side of the equation.
The cost cutting has left relatively few areas untouched. In fact, many companies have cut through the muscle and into the bone as employees have primarily born the brunt of these cost reduction measures. Managements, either operating in or threatening to enter bankruptcy, have forced deep concessions across the full spectrum of compensation. The cost cutting has also spread to aircraft lessors, vendors, and contractors that have left everyone in direct contact with the industry financially weakened. While the airline industry comprises a relatively small portion of our economy and is only one sub-sector of the Transports, it touches a broad range as it gauges the movement of people and goods throughout our country and the world.
The extensive scope of the Transports is why Dow Theory considers the DJIA and the Transportation Index as mutually dependent for confirmation of primary market trends.
Here's a quick review of the basics of Dow Theory:
- The Dow Theory looks at only the movement of the Dow Jones Transportation and Industrial Averages. Under the Dow Theory, no other Averages are used for interpretation purposes.
- These two Averages discount everything. The fluctuations of the daily closing prices of the Industrials and Transports take into account all hopes, disappointments, and knowledge of all market participants.
- There are three movements to the market. The most important movement is the market's primary trend, a broad trend lasting from less than one year up to several years. The second movement is the secondary price movement, usually lasting from three weeks to three months. The third movement is the daily price movement, which has very little long-term forecasting value under the Theory.
- Both the Industrial and Transportation Averages must confirm. The movements of both the Industrials and Transports should be considered together. Conclusions based on the movement of one Average, unconfirmed by the movement of the other, are often erroneous.
- The primary trend remains intact until a change in that trend has been given by the Theory. The last major signal remains in force until a new signal develops. Many analysts believe that a bull market must always be moving to new highs. However, the market can undergo extended periods of sideways or lackluster trading without the primary trend changing. If the last major signal under the Theory was bullish, the primary bull market trend remains in force until a bear market signal is given.
In addition to the airlines, the Transportation Index includes shipping and rail companies making it a widespread gauge of the overall health of the economy. Simply stated, you can't have a healthy economy if things aren't moving; healthy transportation stocks are the sign of a healthy transportation industry.
Here's a list of the DJTA components:
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Dow Jones Transportation Average
(click for StockCharts)
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Looking back on the recent DJIA high, the Transport Average failed to confirm as it broke down more than a month prior signaling the likelihood of a corresponding breakdown in the DJIA. (All charts courtesy of StockCharts.com)
While there's widespread technical trouble in many of the individual Transport stocks, I want to focus only on the passenger airlines which are the heaviest drag on the Index.
AMR, the World's largest airline, broke through its trend line after the Transports dropped, but it's currently holding right at support.
Probably the ugliest of all the charts is Delta. As the World's third largest carrier, it stands at a critical level. If this support level falters, then DAL may be in the process of being priced for bankruptcy. On the other hand, if support holds, then a triple bottom may be forming. This chart was weak and deteriorating long before either the Transports or the Industrials broke down with Delta losing nearly half its value in 6 months.
Northwest has broken down through its trend line and first level of support simultaneously with the Transport Average. It also sits just above the next support level with nearly a 30% loss coming since its recent highs.
Continental appears to have been topping for sometime with the support breakdown coinciding with the Transport's breakdown. Also, notice it sits on top of the next support level with around a 40% loss since the top in October 2003.
Finally, Southwest, which is typically the darling of Wall Street, is looking extremely weak. Support was broken decisively on heavy volume in early December. The entire current downtrend has occurred on above average volume with LUV losing 25% since November. It will take a climb above the broken support to positively reverse this trend.
In summary, the airline stocks are weak and deteriorating with many sitting on critical support levels. Under these circumstances, a quick reversal in the DJTA is unlikely, so any corresponding upward move in the DJIA will go unconfirmed. Furthermore, the airlines represent a systemic problem that may begin manifesting itself throughout the economy.
There's clear evidence that a lack of pricing power currently exists affecting the entire airline industry's revenue generation. Moreover, the government has blocked all consolidation attempts necessary to achieve economies of scale and eliminate supply overhang that would restore some level of price stability. This widespread problem has forced the carriers into a defensive posture causing them to attack the cost side. This cost cutting has reduced revenue generation for support companies as well as disposable income for employees. This could metastasize to other sectors ending in a contraction of the money supply as people and businesses have less money to spend. It's because of this contraction that the deflationary forces have the airline industry........
......standing in the vortex.
March 28, 2004
David Chuhran
goldwings@bellsouth.net
Copyright © 2004 David S. Chuhran. All Rights Reserved
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