Warren Buffett’s Favorite Indicator Warns of Trouble

Maybe you’ve played the “desert island” game. This involves naming the one thing you want if stranded on a desert island. For example, your desert island book might be Aesop’s Fables to relive your childhood.

Market analysts often ask each other what their desert island indicator is. Warren Buffett, the world’s greatest long-term investor, named railcar loadings as his favorite indicator.

The chart below shows this indicator along with the S&P 500 Index. It’s not good for the S&P 500.

Desert Island Indicator

Railcar loadings is the number of carloads the nation’s railroads carry. Analysts confirmed rail traffic is closely tied to economic growth.

The chart above shows the indicator also offers insight into the stock market. Rail traffic tends to lead trend reversals in stock prices.

Rail traffic headed higher before the bear market ended in 2002. The indicator fell and signaled the end of the bull market in 2007. It bottomed at the same time as the S&P 500 did in 2009.

Now, it’s signaling a sell-off in the stock market is near.

You can see the indicator never reached its old highs after the 2009 recession. That’s because of changes in the economy.

Coal accounts for part of the decline. The U.S. mines and ships less coal than it did before the crisis. This is because of new environmental regulations.

There’s also been a decline in shipping paper and paper products. That’s because the internet replaced newspapers and magazines.

This demonstrates why we have to understand economic indicators. Without digging deeper and learning the decline is due to coal and paper shipments, we might think the chart shows bad data.

This indicator is not broken. In fact, it works just like it always did. The only difference is that the absolute level of rail traffic is now at a much lower level than it was in the past.

As in the past, the trend of railcar loadings is the important factor to consider. That’s because an increase in loadings shows the economy is growing. A decrease in loadings comes as factories produce less and therefore require fewer raw materials.

Railcar loadings peaked in June 2017. Stock market declines often follow peaks in the indicator.

Warren Buffett’s desert island indicator is another reason for caution. It’s warning that trouble lies ahead of the stock market, and few investors see it coming.

Regards,

Michael Carr, CMT
Editor, Peak Velocity Trader