In a recent CNBC interview, Warren Buffett was asked to identify one economic indicator that he would consider most relevant for evaluating overall economic conditions if he was stranded on a desert island for a month and had no other access to information.  He immediately mentioned rail car loadings as a top candidate for this “desert island indicator”, and has made similar comments in the past.

Let’s assume that Mr. Buffett received the Association of American Railroads September Rail Time Indicators report and had to draw some conclusions regarding the state of the overall economy.  The report actually includes a significant amount of information that is not directly related to rail shipments, so let’s just focus on a few of the indicators published in the report that pertain to railroad indicators:

• “U.S. freight railroads originated 1,116,182 carloads in August 2009, down 16.4% (218,593 carloads) from August 2008 and the 10th straight double-digit monthly carload decline. However, the percentage decline in August was the lowest since February 2009.”
• “Average weekly carloads on U.S. railroads in August 2009 (279,046) were more than 15,000 carloads higher than in July 2009 and higher than any previous month in 2009, though seasonal factors account for some of that increase…”

Looking at the report’s breakdown of rail traffic by commodity type, nearly every category still shows double digit declines from the prior year, although as the report indicates, traffic has improved significantly from the depths of the recession earlier this year. There are numerous charts in the report that show more granular details.

The rail indicators seem to show an economy that is improving but still significantly depressed compared to the period prior to the September 2008 meltdown in financial markets.  Average weekly carloads still falls far short of the levels seen in 2006 and 2007.  While year over year comparisons will improve starting in October, it does not appear that predictions of a “V” shaped recovery can be supported by this indicator.

Obviously rail traffic is just one indicator of economic activity but it deserves special consideration given Mr. Buffett’s recommendation and is something to keep in mind for those who are making investment decisions predicated on an assumption of rapid improvements in economic activity in the 4th quarter.

In general, making investment decisions based only on macroeconomic factors is not consistent with a value investing approach.  However, the investment thesis for many companies can be influenced to some degree based on whether an investor is assuming a quick return to rapid growth or a longer period of relative stagnation in the economy.  It is dangerous to look at average earnings of a company from 2005 to 2008 and assume a rapid return to those levels if the company is particularly exposed to macroeconomic factors.