A Trade War Could End Transport Bull Market

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A Trade War Could End Transport Bull Market

On Tuesday, the Dow Jones Transportation Average reversed at four-month resistance as the Trump administration shifted gears and announced the next step in slapping tariffs on Chinese imports. The sell-off reflects rising concern about supply chain disruptions, which might bring an end to the multi-year bull market, as well as a tardy reaction to the failure of NAFTA negotiations and the prospect of 25% tariffs on imported autos.

If recent changes are just bargaining tactics that result in compromise and agreement in the coming weeks, the transportation industry should rise. If the inverse is true, top sector components might fall 15% to 25% in a few sessions, resulting in aggressive short sell gains. More crucially, the fall would put the February lows into play, laying the groundwork for an intermediate slump that might last months or more.

Railroads and truckers seem to be top short sale prospects if NAFTA is scrapped, since these businesses are at the front lines of the fight against globalization and imported commodities, particularly in North America. Meanwhile, if a full-fledged trade war between the United States and China breaks out, airlines and packaging businesses might suffer the most, with fewer volumes and unfilled seats cutting profits. (See also: Transportation Industry Analysis.)

The iShares Dow Jones Transportation Average Fund ETF (IYT) reached a multi-year high of $168 in 2014 before falling to a two-year low of $115 in January 2016. After the presidential election, it rebounded to resistance and eased into a shallow rising channel that broke to the upside in December 2017. Six weeks later, the fund hit an all-time high of $206.73 before falling down and rebounding off range and 200-day exponential moving average (EMA) support at $180.

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Two additional tests at support found willing buyers, while three rally waves failed to pierce horizontal resistance above $195. The fund reversed at that level for the fourth time on Tuesday after a seven-day test, exposing another sell-off to range support. On-balance volume (OBV) has deteriorated since mid-April, pointing to a shrinking supply of buyers while exposing a breakdown that could reach the $160s. (For more, see:Tips for Trading the Dow Jones Transportation Average.)

Kansas City Southern (KSU) operates major north-south railroad routes and has the most to lose if NAFTA goes belly up or trade barriers raise the cost of Mexican-produced parts. The stock hit a five-year low at the end of last decade’s economic collapse and turned sharply higher, entering apowerful uptrend that topped out just above $125 in 2013. A 2014 test at that level attracted aggressive sellers, while the subsequent downturn completed a double top breakdown in 2015.

Buyers returned in 2016 after the stock posted a three-year low, generating two rally waves that stalled at the .786 Fibonacci sell-off retracement level in November 2017. Two breakout attempts have failed since that time, with narrow sideways action generating a holding pattern while politicians decide worldwide trade policy. A violation of the May low at $104.43 will issue a preliminary sell signal in this scenario, while a break of year-long support at $99 will complete a major breakdown that could reach the upper $70s.

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American Airlines Group Inc. (AAL) shares fell to a two-year low in June 2016 after falling within seven points of its 2007 peak in the low $60s. In December 2016, the succeeding rally faded into a rising channel, eventually hitting 2015 resistance in January 2018. In April, it fell to channel support and then broke down, also breaching support at the 200-day EMA. A few weeks later, the sell-off stopped at the 2017 bottom, resulting in a bear flag rebound that has already surpassed 50-day EMA resistance. A flag collapse will trigger bearish continuation signs, increasing the likelihood of a fall to close the July 2016 gap between $31.50 and $33. (For further information, see Key Financial Ratios for Airline Companies.)

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The Bottom Line

Transportation has entered a holding pattern that might result in successful short sells if the Trump administration follows through on vows to cancel NAFTA and apply Chinese tariffs. (For further information, see The Fundamentals of Tariffs and Trade Barriers.)

Disclosure: At the time of publishing, the author had no investments in the aforementioned securities.>

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