A warning from Warren Buffett’s top economic indicator

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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