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XMFSinchiruna (26.50)

Sinchi Alert: Danger - Step Away from the Railroad Tracks



April 16, 2009 – Comments (9) | RELATED TICKERS: CSX , BTU , PKX

Danger: Step Away from the Railroad Tracks

If you haven't already, please take heed. This rally is running on fumes, and has the potential to steamroll your nest eggs if you decide to adopt this unsupported -- though completely understandable from a psychological perspective -- spirit of optimism that seems to have hypnotized investors.

With so many headline-grabbing events transpiring at once, I'm finding that fewer investors seem committed to scrutinizing earnings reports, but ignoring the information coming out of these bellwether companies is like putting on a blindfold and basing investment decisions on the worthless babble of public figures like Cramer and Kudlow.

I know Fools are smarter than that, but some may understandably find themselves succombing to the temptation of positive thinking and looking to will this depression out of existence. Depressions are in part psychological phenomena, in that they are self-perpetuating events for as long as excessive leverage remains locked up in the system. Psychological factors, however, are only an impediment to recovery after the de-leveraging is complete, and since the injection of $13.5 trillion has sought to prevent that very de-leveraging process (succeeding only to postpone it, by the way), we are nowhere near the point where all it would take to turn things around would be the will of the people. The will of the people, as powerfull a force as that can be, is simply no match for a $1 quadrillion mountain of worthless toxic derivatives.

This Train is About to Derail

What I'm trying to convey here is so much bigger than any one sector, but railroads are an incredibly effective barometer for economic activity, and when considered in conjunction with my reports from similarly indicative sectors, which I'll link below, some irrefutable facts about the current degree of weakness in the American economy can easily be ascertained. Please be patient as we start by looking at railroads.

This is by no means intended to single out CSX, which like the rest of the North American rail companies is extremely well-run and as efficient an operator as can be reasonably expected. I'm using CSX simply because it's first to report earnings, but each successive railroad earnigns report coming out over the next week or so I'm quite confident will confirm my causes for concern. The factors colliding to build this troubling environment for railroads are indiscriminate in their looming impacts upon the entire sector.

In case you missed it, here's the link again to my latest article.

As I point out therein, I sounded the alarm on the railroads first back in January, noting major deterioration of the underlying freight categories. As I predicted, those volumes have only continued to deteriorate further, with even the former standout coal experiencing a major downturn. At the time, I was blasted by more than a few investors for daring to suggest that those stocks would head further south, but south they went. I find it very curious when an entire sector reverses direction in a single day in tendem. Sometimes, as in the case of gold and silver back in October and November, we saw convincing sector-wide reversals on precise trading days that were based upon identifiable developments. The railroads, however, reversed on March 9th not because anything material changed for the sector, but merely because investors began piling into an equity marketplace that had retreated abruptly to a 12-year low. This was a psychological event driving a 30-50% rally in a sector for which fundamentals have only grown bleaker. That, my Foolish friends, is a recipe for disaster. Incidentally, nothing fundamental has changed that would account fo this overall rally either... it's all one big psychological reprieve supported by a desperate spin machine.

For the record, here are the four articles from January warning of lower share prices coming for the railroads. If anyone happaned to heed those warnings and wait until early March to dip into railroad stocks, A.) you're welcome, and B.) run while you can! :)

Bound for Glory, but This Train May Stop

Get a Better Deal than Buffett

Less Gravy on the Train

Railroads' Brakes Beginning to Screech

I've been sounding this broader warning about just how impaired our domestic economy has become through related sectors like steel, coal, and equipment manufacturers:

Blog posts:

Peabody Issues Global Report Card

China is Heating Up

The Ultimate Commodity Update

And related articles:

Peabody's Play Within a Play

The Sheriff of Steel Strikes Again

Terex Goes on the Offensive

The Ultimate Commodity Update

Evidence is mounting in droves, we have an enormous amount of financial pain to wade through before we can even begin to think about recovery. This wil not reverse in an instant the way the Dow did recently. When it happens, it will not come as a surprise to anyone because we will have been in the thick of it for an extended and grueling period.. forced to go back to paying attention to fundamental indicators like the earnings reports from bellwether sectors. Buckle your seatbelts, Fools, and gt off the railroad tracks, cause this rally train is bound to derail.

As always, I am sorry for being the bearer of bad news... it is not arole I enjoy in the least. I am neither a pessimist nor a perma-bear by nature, but I do consider myself a realist. When I find real evidence piling up the way it is right now, I consider it my duty to sound the alarm for all of you.

Good luck, consider easing into some larger cash positions for the next stopping point south of 6,000 on the dow, and look for shelter in precious metals in the meantime... they're conveniently on sale.

DYODD, but those are my $0.02




9 Comments – Post Your Own

#1) On April 16, 2009 at 6:39 PM, SARG0N (26.78) wrote:

"Nothing fundamental has changed that would account for this overall rally either... it's all one big psychological reprieve supported by a desperate spin machine."

It seems like you have this down exactly, Good post.

Today, “General Growth Properties Inc, the second-largest U.S. mall owner, declared bankruptcy on Thursday in the biggest real estate failure in U.S. history.” Paradoxically SRS dropped nearly double digits. The Market seems like it is ignoring all bad news which is reminiscent of the long rally after Bear Sterns fell last year.

Another thing which speaks against this rally is that some of the worst companies have been among the largest gainers. For instance WMG was up today almost 20% and is at 4.62 from its recent low of 1.58. It’s all psychological and people seem intent to ignore the real facts and blindly march off the edge of a cliff.

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#2) On April 17, 2009 at 1:56 AM, goldminingXpert (28.68) wrote:

Somebody isn't drinking enough bull kool-aid. Come on man, it's a new BULL MARKET! ;)

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#3) On April 17, 2009 at 8:51 AM, dudemonkey (53.96) wrote:

Your warnings and analysis are, as always, most appreciated.  It's good to have some longer-term perspective in the midst of a recent strong rally.

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#4) On April 17, 2009 at 10:27 AM, amassafortune (29.15) wrote:

This rally is not justified by earnings, but S&P 995 is 15% up from today's 865 starting point and most analysts think we will get there sometime this year. It is perfectably reasonable to get in at this level in a broad-based fund, with a tight trailing stop, and ride this deranged bull until it collapses. 

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#5) On April 17, 2009 at 3:45 PM, XMFSinchiruna (26.50) wrote:

For another perspective:

While a large portion of the country prepares for (and, in some cases, has already begun) a rebound in the stock market, certain industries continue to plummet. Freight companies, like CSX Corp. (NYSE:CSX), are unfortunately among the latter. 

CSX reported first-quarter earnings that dropped by 30%, as it carried lower freight volume. Revenue fell by 17% to $2.2 billion, while net income was $246 million, or 62 cents a share (down from $351 million, or 85 cents per share, in the previous year's same quarter). The report showed the pressure the freight industry was under while CSX, the nation's third largest carrier, continued with cutbacks and furloughs. The earnings did beat analysts' estimates.

Rails are Still Central
Despite this being the virtual age, goods are tangible and must be made and shipped, so the transportation and freight industry is still critical. In mid-March, with the Dow Jones Transportation Average (DJTA) sporting the better part of its 40% rally, things were looking up. Union Pacific (NYSE:UNP) stock popped 5% after an upgrade with the idea that spring farm work would increase, along with an optimistic view that chemical and autos would rebound, yet the stock has been stuck for obvious reasons: the industrial uptick didn't happen.

Burlington Northern Sante Fe Corp (NYSE:BNI) looked poised for big things. The railroad is nicknamed "The Buffett Railroad" for its famous investor, Warren Buffett, who was still picking up shares as recently as January to bring his stake in the railroad to 21.8%. Though the railroad has been described as "ailing," the stock had a great fourth-quarter earnings report, unlike CSX,  yet also has gone nowhere. The decent Burlington Northern earnings were largely from lower fuel costs and higher surcharges on its customers. How much pricing power the railroad will have going forward in this heavy recession is a matter of concern. 

Canadian National Railway (NYSE:CNI) is still feeling the heat north of the border as it is also fighting to hold the line on earnings. The Canadian economy, which is rich in natural resources that are a staple for rail transport, is also tied heavily to the U.S. economy, and intimately so for Canadian National, as it has many routes which routinely criss-cross the U.S. in its daily business. There is potential for Canadian National to pull out of the rail doldrums first, if the Canadian minerals and forest products spring back before heavy industries or U.S. retailers do. (Learn more in Build Your Portfolio With Infrastructure Investments.)

Norfolk Southern (NYSE:NSC) had a similar story to CSX, in that it reported lower freight volume at the end of January but made out with pricing power. With all the major railroads reporting similar dynamics, it's confirmed the industry-wide nature of the conditions and trends. Some, such as Norfolk Southern, may have managed around these conditions better than others, as its earnings increased 13% year-over-year in that fourth quarter. As good as Norfolk Southern is, neither they nor any of the other major railroads seem to have any special elixir for overcoming the ongoing slowdown in freight traffic.

Look for a Business Catalyst First
While lower fuel costs, improved pricing power and expert management can help the bottom line, the economy has to improve to reverse this trend. In addition to CSX furloughing workers, it's putting some of its engine fleet temporarily down, so these are not signs of confidence in a short-term turnaround. Without a positive catalyst, the industry will remain in the same state. Meanwhile, CSX is seeking accommodations, should further trouble beset the automakers. While this is prudent planning, it's not a sign of confidence in the near-term. (These diverse asset classes provide downside protection and upside potential, see Commodities: The Portfolio Hedge.)

Last Stop
Some observers have dire forecasts for the rails - specifically CSX - predicting the potential of a long-term negative trend, while others see the rails as still solid companies, which will weather this downturn just fine. Norfolk Southern seems to be the best, while CSX's exposure to poor economic conditions has been a struggle. Investors shouldn't just jump on board before looking at a sustainable rebound.

By Greg Sushinsky

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#6) On April 17, 2009 at 4:23 PM, XMFSinchiruna (26.50) wrote:

My new favorite CAPS blogger, speedybure, added some empirical evidence of his own.

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#7) On April 17, 2009 at 4:49 PM, XMFSinchiruna (26.50) wrote:

And this from brilliant Fool contributor Alyce Lomax:

She brings ths discusion back around to the macroeconomic fundamentals that I've ben focused on as well.

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#8) On April 17, 2009 at 4:58 PM, Xciteddon (66.17) wrote:

Thank you again for your wisdoms! It can also be said that because the economy is down there is less being produced and therefore less shipped anywhere. Whether by rail or by truck. This will effect transport companies eventually worldwide, including ships, trains, trucks and planes. This mess is just starting. I agree with you. Have a great Day!


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#9) On April 17, 2009 at 5:46 PM, XMFSinchiruna (26.50) wrote:

a Crude Awakening for oilfield Services

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