2019: Long US transportation, short aerospace and defence

We said:

We have written how weakness in US new goods orders reflects sagging world trade. EU data releases have further darkened the global outlook, with confirmation that Germany’s economy, the EU’s largest, shrank in Q2. We have also highlighted the extent to which the rest of the world is slowing more abruptly than the US.

We add a trade to the theme of US growth outstripping the RoW. We go long US Transportation and short US Aerospace & Defence. With momentum in the global economy lagging that in the US, we believe Aerospace & Defence will be a relative loser as it is very dependent on non-US earnings. China is a particularly important market. Earnings growth has been strong in the past few years, but we doubt this can be sustained in the current global trade climate. Valuations are also expensive at 21.6x forward earnings.

Conversely, US Transportation is leveraged to the US domestic economy. The sector encompasses freight as well as last-mile delivery. Ahead of the potential increase in tariffs on Chinese imports later this year, not to mention the year-end holidays, we expect significant stockpiling in coming months, which will be positive for freight. At the same time, relatively buoyant consumer spending remains a tailwind for last-mile delivery companies.

We therefore buy the IYT ETF (iShares Transportation Average) and sell the ITA ETF (iShares U.S. Aerospace & Defence). Transportation’s p/e is 13.3x forward earnings (2.7 points below the 10-year average). The differential with Aerospace’s 21.6x valuation provides a good margin of safety for the trade.


We closed the trade on 23 October for a profit of 6.58%.


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