A warning from Warren Buffett’s top economic indicator
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Investment Director – The Fleet Street Letter
David Stevenson Mar 05, 2012
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Warren Buffett has to be one of the top investors of all time.
Even those who question whether his best days are behind him have to admit that he’s one of the most influential movers and shakers in the markets.
That’s why it’s worth keeping an eye on what Buffett is doing – and on what he’s watching.
So today we want to take a look at Buffett’s favourite economic indicator. It’s the one that tells him all he needs to know about the US economy.
And it’s not looking good…
Warren Buffett’s ‘desert-island’ indicator
In a 2010 interview with CNBC, Warren Buffett was asked which single set of economic data he’d request access to if he were stranded on a desert island.
Buffett’s response? Freight car loadings. These show the volume of raw materials and industrial supplies being moved by rail around the US every week.
Why is Buffett so keen on such an old-fashioned sounding indicator?
Because all the stuff that’s being transported by America’s railways will at some stage get used. It will either be processed into finished goods for sale, or stored as inventory. In the latter case it should be pressed into service at a later date.
As inventory levels drop, more raw materials are likely to be ordered by manufacturers to plug the gaps in the stock warehouse shelves. That will be reflected in future freight car loading figures.
In other words, freight car loadings are a nice and simple, useful and very accurate early warning guide to the future direction of the US economy. They are, if you like, the American land-based equivalent of the Baltic Dry shipping rate index, which I wrote about a month ago.
And the other handy thing about freight car loadings is that you can easily find out what’s going on. Up-to-date information is published every week on the Association of American Railroads (AAR) website.
Buffett’s top indicator is warning of slower growth
So what’s the latest from the AAR? Last Thursday’s report didn’t make very encouraging reading at all.
For the week ending 25 February, the number of carloads moved by US railways dropped by 5% year-on-year. ‘Intermodal’ volumes – i.e. for trailers and containers where the form of transport is switched, say between road and rail – dropped by 2.8% on the year.
And this slowdown seems to be gathering pace. For the first eight weeks of 2012, US railways reported that cumulative carload volumes were down 0.3% on last year.
These numbers in isolation, of course, don’t give us the full picture. For that we need to see how freight car loadings have performed compared with the overall US economy over a lengthy period of time.
When we look at the chart below, we can see why Warren Buffett is such a big fan of the AAR numbers.
Source: Bloomberg
The black line shows the AAR figure for overall North American carload units shifted. Note that this also includes Canadian and Mexican rail shipments, though the US accounts for around 75% of the total. Further, because the numbers jag around week by week, I’ve smoothed the stats using a ten-week moving average.
The blue line is the year-on-year change in US GDP. As you can see, this has been turning up recently. But as the latest drop in the black line shows, this improvement may well not last. If Buffett’s favourite indicator is anything to go by, America’s economy could soon be slowing down again.
The stock market is warning of a slowdown too
Importantly for investors, there’s confirmation of the above trend in America’s stock market.
The Dow Jones Transportation Average (TRAN) consists of shares in firms that shift people or products around, like haulage firms, airlines, railways, shippers and delivery service providers.
The TRAN is widely seen as a harbinger for the Dow. Again, history shows that if the TRAN takes a tumble, the rest of the stock market is likely to follow on behind. And the TRAN is heading down.
I’ve written further about what this fall in the TRAN means – and lots more in a similar vein – in this week’s Fleet Street Letter. If you’d like to find out more about FSL, and get a free report about what could be in store for us here in Britain, just click this link.
But for now, these trends in both freight car loadings and the TRAN point to our long-standing advice to hold defensive stocks. These don’t require economic growth to make their money. And because several of them haven’t joined in the stock market’s recent rally, there’s still some decent value to be found.
Indeed, in last Thursday’s Money Morning, John Stepek came up with a “high-quality, reasonably priced” suggestion.
David writes for The Fleet Street Letter, Britain’s longest-running investment newsletter.
Find out more about The Fleet Street Letter and David's research here.
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