What's happening to transports? Is it a case of missed signals, or mixed signals? And how would Sherlock Holmes unlock  the secret?

Ah, the power of observation! As the great Sherlock Holmes would say to Dr. Watson, it's elementary. There have many books written on the superior skills of deductive reasoning the talented Sherlock Holmes acquired. One of the most notable skills was that he observed things that other people missed. He often said, "You see, but you do not observe, Dr. Watson."

The distinction is clear. Being  observant and taking time to spot the things that often get overlooked when people panic, assume, and rush around without consideration for the finer details are the keys to thinking like Sherlock and giving you an edge. I say this because the herd is often wrong, too emotional, and too trigger-happy to dump shares prematurely before all the facts are known. I think that is the case right now with the transports (as represented by the iShares Dow Jones Transportation Average ETF (IYT).

Stocks ended lower on Thursday, led by transportation stocks due to disappointing numbers from Union Pacific (UNP).The Dow Jones Transportation Averageis now lower by over 11% year-to-date, barely holding onto its 50-day moving average since April.And now the 200-day moving average is showing signs of rolling over, a harbinger of an ill wind looking further out. Sherlock would be particularly focused on longer-term. 

Seasonally, between mid-July and early October is the peak period of weakness for the industry, usually due to high energy prices in the summer months.Aha! This time it is different, so this weakness is flying in the face of our current glut in supply you say? Not so fast; you can't discount the fact that overall, depressed energy prices are challenging the industry as well. 

And don't forget about natural gas.Low energy prices have made natural gas more competitive with "old man coal," which saw freight volumes at Union Pacific drop by a whopping 26% in the second quarter.Union Pacific stock sold off  on that news.

According to the US Department of Energy, natural gas recently overtook coal as  the number one source for US electricity grid, a trend that will be the new norm. This comes at a time when the strapped consumer could use a break in their utility bills as well. This summer's scorching heat wave has been relentless. 

So, observes our Mr Holmes, transports hit a low in the fourth quarter. For the dip, this provides a buying opportunities through November. Elementary! And as you can see, this vast landscape of companies that reside in the index is one reason it gives so many "flawed" signals.It contains too many players with different exposures like macro events, supply demand issues, geopolitical machinations and the dreaded commodity space. Quite a hybrid. 

Take the rails for instance. The rails like Norfolk Southern (NSC) have been waving a lot of red flags on the coal business and the oil glut. The rails in Canada like Canadian Pacific (CP) and the ones in Mexico like Kansas City Southern (KSU) are being particularly hard hit now. Both economies Canada and Mexico are too tethered to commodities right now, much like Brazil and Australia. 

The frackers are also problematic and  another dying revenue stream for the rails due to the oversupply of oil. Thank you Saudi Arabia and now Iran. Our domestic refiners are the only bright spot on the entire energy landscape. Marathon, Valero, and Tesoro are all making money. But they are the exception right now in the oil space. Less demand for product means less demand for transporting product.

The airlines have been hit hard on fuel costs in the past. The CEOs of  Southwest Airlines (LUV) and Spirit (SAVE) recently have said their planes are full, business is good, and since both are hedged, are realizing great savings in fuel costs.  

The rails are exposed to coal, the truckers are exposed to a weak economy, housing, a constrained consumer, and increasing government regulatory control.

These are the top 10 holdings in the IYT; you can see there is quite a cross-section:

Top 10 Holdings (67.7% of Total Assets)        

Company         Symbol            % Assets

FedEx Corporation  FDX    13.07

United Parcel Service, Inc.       UPS     7.61

Union Pacific Corporation    UNP    7.24

Kansas City Southern  KSU    6.92

Norfolk Southern Corporation      NSC     6.67

Ryder System, Inc. Common Stock     R          6.28

Landstar System, Inc.  LSTR   5.25

C.H. Robinson Worldwide, Inc.          CHRW 4.90

Alaska Air Group, Inc. Common   ALK    4.89

J.B. Hunt Transport Services       JBHT   4.87

To be fair, the IYT has been in an uptrend since the Reagan years so let's not get too hysterical on this selloff. There is a silver lining even in the IYT nimbus clouds many may have overlooked. Sherlock would be proud.  

In the end, heed the words of Holmes if you want to be ahead of the crowd in understanding the IYT.Holmes advised that "It is a capital mistake to theorize before one has data."  In other words, don't twist facts to suit theories; adjusttheories to suit the facts.

For the time being, I would avoid buying the IYT. It has failed bounces to the 50 DMA and the relative strength is at a multi-year low.