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The second quarter is officially under way, after the market's very impressive performance in the first quarter. At least, that's the way it appears on the surface, if you look only at the major indices. But if we look beneath the broad market and delve deeper into individual sectors, we find an abundance of underperformance.
By now, everyone is aware of the weakness in coal and mining stocks, some of which are so beaten down that they are difficult to short. I'd prefer to seek out sectors that have failed to keep pace but still have plenty of downside potential. One area that is about to be freight-trained is the railroad sector, represented here by the Dow Jones U.S. Railroads Index. Notice how badly the DJUSRR has lagged behind the Dow Jones Transportation Average (DJT) since the beginning of the year. As of yesterday's close, the DJT (green) is up 4.73% year to date, while the DJUSRR (red) has lost 1.09%.
The daily chart of the DJUSRR is troubling, revealing the clear formation of a head-and-shoulders top whose neckline coincides with the index's 200-day moving average (red). Meanwhile, the 50-day moving average has begun to tilt downward (blue). These are signs of weakness under any circumstances, and they are particularly troublesome when spotted in the midst of a bull run.
Of course, we could view this performance in the context of money rotating away from a staid sector in favor of greener pastures. While some large-cap names in this sector, such as Norfolk Southern (NSC), are having a rough ride, I'm going after a less familiar and less diversified name that I feel has greater downside potential. The stock that appears as if it's about to be sidetracked is FreightCar America (RAIL).
Since reaching year-to-date highs at the end of February, FreightCar has lost 19% of its value and is now finding support on its 200-day moving average (red). If and when this stock closes beneath its 200-day MA, it'll be time to sell short.
Compare the size of the volume bars on the left and right sides of the chart. As the stock began to slide, volume increased dramatically. At the beginning of the year, RAIL's daily average volume was just over 100,000 shares; now it's over 200,000 shares per day, on the basis of a 50-day average.
Why is this stock in jeopardy? FreightCar America manufactures aluminum-bodied railcars, and the vast majority of those are designed to carry coal. I mentioned earlier that coal companies were already hammered but difficult to short. FreightCar, on the other hand, presents a tertiary play on coal miners, yet it is only one month removed from its year-to-date high. Essentially, FreightCar is a coal stock by association, but it hasn't yet suffered the punishment that those names have taken.
What are the analysts saying about FreightCar? The company did receive one upgrade recently, when UBS raised its rating on the stock to Neutral -- talk about damning with faint praise! It gets worse: Yesterday, Jefferies cut its price target from $31 to $29, and last month, KeyBank lowered its rating from Hold to Underweight. One analyst firm, Longbow Research, even slapped the dreaded Sell rating on RAIL, with a price target of $16. In order for RAIL to reach that price, it would have to fall 28% from yesterday's close of $22.25.
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