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Riding the road to recovery

March 14, 2013: 10:57 AM ET
Transportation stocks are not only decent buys, they're signaling full steam ahead for the market.

Transportation stocks are not only decent buys, they're signaling full steam ahead for the market.

This article was published in the April issue of Money magazine.

This may be an online, on-demand world, but as long as businesses still need to ship stuff to customers, transportation stocks will remain a key barometer for investors. That's why Dow Theory, a market-timing indicator rooted in the smokestack economy of the late 19th century, remains relevant in the digital age.

This once-popular gauge tracks the Dow Jones industrial average (INDU) as well as the lesser-known Dow Jones transportation average (DJT).

If the 20 railroad, trucking, shipping, and airline stocks in the DJT climb to new highs at the same time the Dow industrials are surging, investors view that as bullish. Conversely, when the DJT slides, it's a harbinger of bad news -- as was the case in the summer of 2007, just before the recession.

Related: Cashing in on the consumer rebound

The transports are at all-time highs along with the Dow, which hit a new record of above 14,500 last week.

"Seeing the transportation stocks do well along with the broader market is a good sign for the economy," says John Kosar, director of research with Asbury Research.

But is it too late to invest in the transports themselves? Not necessarily, as the recovery these stocks are signaling is still in the early stages.

Here are three ways to hitch your wagon to this trend:

Ride the rails

Investors are high on railroads because they're a way to capitalize on the nascent U.S. energy boom. "There's a lot of new oil and a lack of pipelines to transport it, and the railroads are more efficient than trucks," says Ryan Wibberley, head of CIC Wealth Management. He owns Union Pacific (UNP).

Oliver Pursche, co-manager of the GMG Defensive Beta Fund, likes CSX (CSX), which trades at a price/earnings ratio of less than 13 based on 2013 earnings estimates. By comparison, the average P/E for rail stocks is nearly 14.

Focus on freight

If the economy is on the verge of improving, the largest parcel delivery service should benefit, says Pursche, whose fund owns UPS (UPS). International deliveries account for about a quarter of UPS's revenue. Mark Mulholland, manager of the Matthew 25 Fund, favors FedEx (FDX), which is expanding into the emerging markets. "It should do well in an economy that's slowly getting better," he says.

To be sure, execs at both firms have been clear that the economy remains tough, but they've taken steps to keep profits growing. And while these stocks aren't dirt-cheap, both are trading well below their historical P/E ratios.

Go with an ETF

Don't want to pick individual companies? The iShares Dow Jones Transportation Average (IYT) tracks the 20 stocks in the DJT.

Related: Is it too late to get in on Pimco's bond ETF?

This ETF counts UPS, FedEx, and three railroad stocks in its top five holdings. In fact, rail-related shares account for nearly a third of IYT's total assets. All aboard!

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Paul Lamonica
Paul R. La Monica
Assistant Managing Editor, CNNMoney

Paul R. La Monica is an assistant managing editor at CNNMoney. He is the author of the site's daily column, The Buzz, and also tweets throughout the day about the markets and economy @LaMonicaBuzz. La Monica also oversees the site's economic, markets and technology coverage.

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