I wrote two months ago about the potential for the stocks of the largest government contractors to perform well as speculators began to realize that U.S. economic activity was greatly underperforming expectations.
I also noted that a shift toward an increase in fiscal spending as a countercyclical response was likely.
I continue to believe that to be the case. But these stocks in the past two months have reflected the immediate underperformance in the economy as a probable negative indicator of near-term potential.
Of the seven stocks listed, which are the largest government contractors, only two are positive during the past two months. Science Applications International Corporation (SAIC) is up about 3% and General Dynamics Corporation (GD) is up about 4%.
CACI International Inc. (CACI) and Northrop Grumman Corporation (NOC) are down by about 3%, Lockheed Martin Corporation (LMT), the largest government contractor, is off by 5%, while The Boeing Company (BA) and Raytheon Company (RTN) are off by about 6%.
This is understandable, and it makes the moves similar over the past few months. Economic data has continued to deteriorate in the second quarter and the Dow Jones Transportation Average has declined about 3% in the past two months and is down 8% year to date.
The Dow Jones Industrial Average (DJIA) has performed better, increasing about .6% in the past two months and year to date by about 1%. The only overlap between the three groups is Boeing, which is included in the DJIA.
There is a significance to the transports declining all year and diverging from the industrials. According to Dow theory, the performance of transportation stocks (airline, railroad, and trucking companies) is a leading technical indicator of the potential performance of the stock market broadly.
The full report on manufacturers' shipments, inventories and orders for April 2015, released this morning by the Census Bureau, validates the negative performance of the transportation stocks. It also emphasizes the continuing negative expectations for second quarter GDP, which is currently estimated to be .8% annualized by the GDPNow model.
The stocks of the government contractors appear to be beginning to follow the transports' lead In the past two months, as well as the continuing underperformance of second quarter economic data.
If that trend continues, the industrials should begin following the transports down and the negative performance of the government contractors could accelerate as well.The aggregate performance of the contractors this year has been better than the industrials and far better than the transports.
If the negative performance trend of the transports continues -- and that appears probable -- there is the potential for an abrupt negative adjustment to the prices for the industrials and contractors. It is also probable that would cause them to come back into alignment with the transports. That would require the Dow Jones Industrial Average to decline by about 10% and the contractors by about 15% on average.
There is no way to hedge the contractors with an inverse ETF but the ProShares Short Dow30 (DOG) would allow for a hedge against a decline in the industrials which should help offset any near term correction in the contractors which would almost certainly move in the same direction.
If such a correction in prices for the industrials and contractors does occur soon it would most probably occur to the broader market indices to an even greater degree.
The importance of this to the contractors, however, is that it would probably provide the necessary bipartisan political will to increase the size of a fiscal response. That should logically cause the contractors to rebound more quickly than any other sector.
