Freight Cars Don't Lie

 | Aug 20, 2014 | 2:52 PM EDT
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Confused about how this market can keep advancing in the face of what can only be considered the mixed Federal Reserve minutes just released? I think I have a solution.

What I do is turn to the transports, because the size and tempo of shipments can be one of the most honest reads of the economy possible. They measure true commerce.

My choice gauge? The rails, more specifically Union Pacific (UNP), which just happened to hit an all-time high today. That in itself tells you something, doesn't it? Union Pacific doesn't hit crack into that all-time-high roster for nothing. It's hitting an all-time high because its freight levels, its car loadings as we call them, are surging.

Now we get granular. What does Union Pacific ship?

Twenty percent of its freight revenue comes from what we call intermodal transferring, and Union Pacific is having a banner year in this business. Why? Because of what I saw when I visited recently with the company's CEO, Jack Koraleski, and that's the burgeoning trans-loading industry, whereby goods are transferred from international to domestic containers. Given where Union Pacific's lines are, we can assume that we have robust imports from Asia-Pacific, a sure sign that business is growing, as imports are a classic tell of real economic strength.  

Next is coal, which encompasses 19% of Union Pacific's car loadings. Coal has been weak. At one time I would have said that a decline in coal means a decline in energy production, a real tale of economic weakness. But given the environmental assault on coal, I am not going to use it as a cyclical indicator. That's just probably more natural gas shifting and nothing more.

Industrial products account for 18% of freight, and all I can say is they are roaring. Why? New housing construction, specifically timber, accounts for some of the increase, and that is bullish on the future of that important industry. Union Pacific is a gigantic shipper of frack sand, the stuff that is put into the ground to bring out oil and gas from all of these shales we talk about. That is another robust sign, because the oil industry is now the biggest job creator in the country.

The strength in this industrial products category dovetails perfectly with two indices that just came out that are showing remarkable strength, namely the Dodge Non-Residential Construction Index and the Architecture Billings Index, both of which are recording exceptionally strong levels of activity -- the latter reached a seven-year high. Why is that so important? Because these are signs of an uplift in non-residential construction, which can be a hiring machine once it gets going, which it surely has not done in ages. Just think about all of the goods and services it takes to build a skyscraper or a new factory or a large infrastructure project, and you will know how important these corroborating numbers can be.

The chemical sector is next at 17%. Here, business is booming, as Union Pacific, in the absence of pipelines, ships oil from the Bakken shale in North Dakota, the Niobrara shale in Colorado and the Permian and Eagle Ford plays in Texas, down to the refineries in the Gulf. We tend to think that when energy is weak, the economy is weak. But these shipment figures tell us something else: We are pumping oil like mad, and the supply is overwhelming demand, a very good sign.

Agricultural products are best shipped by rail, and they account for 16% of Union Pacific's revenue. Aha, here is another piece of the puzzle. The ag numbers here are huge and growing, because we have bumper crops everywhere. It's not demand that's driving down these commodity prices, either. It's supply. Again, that's a bullish read, because it says there is growth without much foodstuff inflation.

Finally, there's automotive at 10% of Union Pacific's freight business. So many people are worried about too many autos and rising inventories. If that's the case, why in heck is this segment doing so well? The answer is that despite what you hear, cars are flying off the lots, and they need to be replenished.

So, what does it all mean? For me it means that the market's move here isn't nearly as confusing or problematic as the picture emanating from the retailers or the commodities or interest rates or analysts' ratings would indicate. The strength in Union Pacific shows me that we have good growth with low inflation, the ideal scenario for higher stock prices regardless of the Fed's read on things. I'm taking a ride on the Union Pacific, and I like the direction of the stock and what its business says for the future of the U.S. economy.

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