Transportation ETFs

The transportation market segment is relatively underserviced by ETFs. There are currently just two ETFs focused specifically on transportation: the iShares Dow Jones Transportation Average ETF (AMEX:IYT) and the Claymore/Delta Global Shipping ETF (NYSEArca:SEA). One possible reason for the dearth of offerings is that the transportation sector is often treated by the market as more as a benchmark-- an advance indicator of general market health and performance, than as an investment vehicle per se.

Since the inception of modern markets, transportation stocks have been a staple of indexing. Assembled by Charles Dow in 1884, the transportation sector was the very first widely used broad market performance benchmark, even predating its better known sibling, the Dow Jones Industrial Average (DJIA).

Barclays iShares fund IYT tracks the Dow Jones Transportation Average. This index holds just twenty transport stocks, mostly trucking and rail freight. IYT has an expense ratio of 0.48% and yields around 1%. Its holdings rotate in tandem with the Transportation Average. The components of the Dow Transportation index change infrequently. This is good from an ETF fee perspective, because it holds down the turnover costs that plague some indexes.

Like other Dow Jones Averages, the transport sector is price-weighted. This means that weightings are determined by share price rather than by market capitalization, so the stock with the highest price has the most influence on the index. As a result, compared to many other ETFs, IYT tends to be pretty concentrated. Just three of its current top holdings, Burlington Northern Santa Fe (NYSE:BNI), Union Pacific (NYSE:UNP), and FedEx (NYSE:FDX) represent about 30% of the total fund.

The mostly domestic Dow Transportation Index, like the ETF that tracks it, has a further problem: it no longer reflects the reality of global logistics. Investors in IYT lack exposure to some of the hottest trends in transportation: world wide infrastructure build out, the direction of bulk goods versus finished goods and more generally the boom in global trade. Claymore's Global Shipping Index fund, SEA, partly makes up for this deficiency by reflecting the realities of global transportation. SEA focuses specifically on bulk seaborne transport, tanker ships operation and leasing, and other industrial shipping, including container ships, specialty chemical ships and liquid natural gas transport.

SEA is more diversified than IYT, holding 30 securities. Currently its largest holdings are less than 5% of the total fund assets. Its domestic holdings amount to around 20%. Greece is weighted at about 35%. Other big international holdings are concerns based out of the Bahamas and Bermuda. Its expense ratio, approximately 0.65% reflects this foreign exposure, which is typically more expensive for domestic investors to capture.

One potential problem with SEA is its newness. Introduced in August of 2008, it retains a small market cap. When Claymore introduced SEA its market cap was around 5 million. Such tiny participation tends to increase fund costs, which in turn are passed on to ETF investors. Because of the limited number of options for investors to access this sector, its importance, and the fundamentally sound portfolio, we think that this fund will gain steam.

One of the key uses for transportation sector ETFs is their application for the Dow Theory, a philosophy which holds that the market is in an upward trend when either one of the two key benchmarks industrials and transports advances above a previous high, and it is subsequently accompanied or quickly followed by an advance in the other. A downward trend can be charted when the reverse happens: first one index breaks to new lows then followed by the other index. Followthrough confirms the trend. From an ETF perspective, the Diamonds Trust (AMEX:DIA) is a handy proxy for The Dow Jones Industrial Average. The chart below shows that, in spite of higher oil, over the last few years the transports have outperformed the industrials:

The chart shows how, according to the Dow Theory, in early 2006 both the DIA and IYT broke to new highs, confirming an upward trend. In late 2007 a downtrend was confirmed. In January 2008 no new trend was put in place. Adding SEA to IYT may provide additional insight into the direction of transports and the market broadly.

Whether its key stock holdings are railroads, as they were in the end of the nineteenth century, or stock in rail, trucking, and shipping concerns, as is the case today, it is easy to see why the transportation sector is thought to be a leading indicator of market health. When the economy is strong, businesses and individuals are shipping goods. When the market slows, a decline in new orders and a consequent fall in the stocks of transportation companies is often one of the earliest signs.