Sunday, August 5, 2012

Growth and cyclical companies not participating in the rally

I thought I would highlight a dynamic in market that many may be overlooking. Below, you see the three-year chart of the S&P 500 versus the price the Morgan Stanley Cyclical Index relative to the Dow Jones Non-Cyclical Good and Services Index.


Now, I preface the following comments on the fact that I have not done a significant, long-term analysis of this apparent relationship (which I hope to do soon), but in my mind there is an intuitive appeal to co-movement in these indexes. The Morgan Stanley Cyclical Index tracks the performance of stocks of economically sensitive companies. In contrast, the Dow Jones Non-Cyclical Good and Services Index follows the performance of companies that are less economically leveraged, hence is defensive in nature. A period of rising relative performance in the cyclical index means either continued economic growth or an outlook for gains in the economy. You would only expect that the S&P 500 would rise in this environment. I would also think the opposite would hold true. A decline in the relative performance means falling economic growth (or an outlook there of) and probably suggests a broader market decline.

Since March of this year, the Morgan Stanley Cyclical index has underperformed the the Dow Jones Non-Cyclical index. In my opinion, this highlights investors' concerns with economic growth. It also suggests that the recent market rise is more related to investors bidding up large-defensive stocks, a flight to safety trade if you will, and that the market is rallying on fumes. I also think that without some resumption in growth, or at least an improved growth outlook, that the market is just building cause for a further downside move.



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