Traders Edge 8/27/12- Cyclical/Noncyclical revisted once again

I have visited and revisited the relative performance of cyclical stocks versus non-cyclical stocks versus the S&P 500 a number of times (including here, here, and here) and yes I thought I would cover the topic once again. I was reading this week's Barron's and the divergences I have highlighted in the past came to mind while reading Jacqueline Doherty's column The Danger in Dividend Stocks. The article details an AllianceBernstein research piece that has looked at the relative value of companies offering out-sized dividend yields, claiming that valuation in these firms are stretched as investors reached for income.

This article got me thinking. Maybe the divergence in the relative performance of cyclical/non-cyclical stocks versus the S&P 500 was the result of investors reaching for yield, as companies that offer higher dividends are usually more mature and less cyclical versus either their higher growth counterparts.

Now just to revisit the original chart, updated for recent data....

Just for your information, the Rel in the above chart is the relative price of the Morgan Stanley Cyclical Index (ticker CYC) and the Dow Jones U.S. Consumer Services Index (Ticker IYC and tracks the Dow Jones Non-cyclical index). You would assume that in periods of growth, cyclical companies and the market would outperform non-cyclical companies, which the data bears out is usually the case.

Looking at this chart, the divergence began- to a lesser degree- in late 2011, but fully bloomed in Mid-2012. Is this an indication of impending market correction? Only time will tell. However, I as implied above, it could also be indicative of investors reaching for yield. What I found, at least visually, is that this thesis could be true, but the evidence appears weak.

For instance, I compared the relative price of the cyclical/non-cyclical indexes versus the yield on the 10-year Treasury Inflation Protected Security, which can be used as a market proxy for the real interest rate on Treasury Bonds.







This may be just an example of hindsight bias, but the late-2011 divergence in cyclical/non-cyclical stocks coincides with the TIP yield decisively going negative. Negative real interest rates may be forcing some investors into higher yielding dividend stocks.  However, there are a number of intermediaries (corporate bonds and preferred stocks for instance) between Treasury bonds and high-yield dividend stocks and the transmission is not likely one-to-one.



But lets just look at high-yield dividend stocks.





The above chart shows the relative price of the cyclical/non-cyclical indexes as compared to the relative price of the Dow Jones IShares Select Dividend Index (ticker DVY) and the Russell 1000 Growth Index (ticker IWF). Companies with higher yields do appear to move inversely with the Cyclical/non-cyclical relative price, bolstering the case that the divergence is the result of investors searching for yield. However, the trend in the relative price of the dividend index versus the Russell 1000 growth index has only stayed within a 12.5% band since mid-2009, and does not exhibit a decisive upward trend that I would have suspected. that said, this could be just an example of my own biases that it not born out by the math, or a problem with the indexes I chose. In any event, I think it bears more research to see if the cyclical/non-cyclical divergence phenomenon is just an example of investors reaching for yield.