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December wasn't a great month for the stock market, and it definitely wasn't a good one for the railroad sector. According to data provided by S&P Global Market Intelligence, shares in Union Pacific (NYSE: UNP), CSX Corporation (NASDAQ: CSX), Norfolk Southern Corporation (NYSE: NSC), and others slumped more than 10% in the month and even managed to underperform the dismal decline in the S&P 500 index. What happened, and should investors be concerned?
Rail traffic data holding up
As the economy goes, so does the transportation sector, so the decline in stock prices is most likely a consequence of negative sentiment on the economy rather than a collection of specific issues. It's no coincidence that the whole sector was marked down in December.
Image source: Getty Images.
What's more surprising is that the decline wasn't accompanied by any deterioration in reported numbers from the industry. While you might expect company quarterly reports to lag end-market conditions -- they are reports on the previous quarter's performance and are given a few weeks after the quarter finishes -- investors can access weekly traffic reports from the Association of American Railroads (AAR).
The good news is if we delve into recent data, it's clear that rail traffic has held up well so far. According to the AAR, U.S. railroad carloads were up 2.9% year over year in December, with combined carload and intermodal originations up 4%. In addition, 2019 has started brightly with total U.S. weekly carloads and intermodal units up 4.8% to Jan. 5 compared to the same week last year.
But for how much longer?
The bad news is that anecdotal evidence and other leading indicators of the economy are suggesting slowing growth, and there's no shortage of uncertainty regarding the U.S./China trade dispute.
For example, as you can see in the chart below, the Institute for Supply Management (ISM) Purchasing Managers Index (PMI) and its new-orders component declined notably in December.
While a reading above 50 still indicates growth, the drop in the PMI could presage the kind of slowdown in U.S. industrial production that occurred in 2015 to mid-2017.
ISM Purchasing Managers Index data by YCharts.
As you can see in the chart below, CSX, Union Pacific, and Norfolk Southern tend to track conditions in U.S. industrial production, and they suffered badly in the last industrial production slowdown.
Moreover, the railroads have significant exposure to any escalation in trade conflict with China. For example, around 21% of Union Pacific's freight revenue comes from the agriculture sector, and any hit to export markets from tariffs by China (the country is usually the largest purchaser of U.S. soybean exports) will hit the railroads hard.