Looking at Cyclical Stocks

One of the market stats I like to keep an eye on is how well the Morgan Stanley Cyclical Index (^CYC) is doing relative to the S&P 500 (^SPX). The cyclical index is made up of stocks that are most sensitive to the business cycle.
It’s important for investors to know if their stocks are cyclical or non-cyclical businesses. Some businesses see their earnings soar or crumble solely due to where we are in the economy. Probably the best example of this is the homebuilders. Even the worst homebuilder makes money when times are good. But when the housing market dries up, it does so dramatically. In fact, the real key to these businesses is working your way through the rough patches. Energy is another good example.
To get my reading, I simply divide the cyclical index by the S&P 500 and this gives me a very rough gauge of how well the economy is doing. I also like this ratio because it follows very definite trends (see the chart below). For example, the cyclical index bottomed out at 0.308 on September 21, 2000 and hit its recent peak at 0.651 on December 28, 2004. That means that cyclical stocks did more than twice as well as the rest of the market.
I’m not bright enough to pick the tops of the bottom of this cycle (I’d be filthy rich if I knew how!), but I like to know where we are in the cycle. Since the ratio hasn’t made a new high in over a year, I’m inclined to think that we’re now in the downswing of the economy. The last such period lasted for nearly 6-1/2 years. I should add that following this index gives you lots of false tops and false bottoms. Cyclicals zoomed in April 1999, but it still wasn’t the bottom of the cycle. Also, cyclicals were hit hard when the market reopened after 9/11, but the cycle still has three years to go.
Cyclical stocks generally outperform the market when the market is rising, so you get a double whammy from owning cyclicals. To be honest, I’d rather know when the tops of bottoms of this cycle are rather than the tops and bottoms of the overall market.
The performance of small-cap stocks also closely follows the fate of cyclical stocks. The reason is that more small stocks are in economically sensitive areas than large-cap stocks.
Don’t count the cyclicals out just yet. Today, the cyclical index is having one of its best days of the year.
doc642.bmp

Posted by on March 14th, 2006 at 2:28 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.