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Cyclical stocks. The term refers to companies with substantial sensitivity to the economic cycle.
When the world (or U.S.) economy is just coming out of a slump or recession, they’re a screaming buy. All the excesses of the previous expansion have been wrung out, leaving them dirt cheap and primed for an acceleration in sales and earnings.
But at or just past the peak of the economic and credit cycle … when you’re only heading toward or into recession … cyclicals can crush your portfolio. Their earnings and sales tank, and their share prices follow right alongside.
I’m bringing this up now because we’ve just seen one of the biggest "Fake Out" rallies in cyclicals I can remember. Stocks with exposure to everything from transportation to chemicals to materials to construction to finance jumped between mid-February and mid-April.
The rationale on Wall Street? China is "fixed," the U.S. is doing fine, so get in there and buy, buy, BUY! Not to put too fine a point on it, but I think that’s just plain nuts.
For starters, the U.S. economy is only tumbling toward recession at this point, rather than coming out of it. GDP growth fell to 0.5% in the first quarter, the lowest in two years. But we haven’t even officially dipped into negative territory yet.
I believe that’s coming next, given the lousy figures we’ve gotten on retail sales, durable goods, bank lending standards, and confidence. Then earlier this week, ADP reported that the U.S. economy created the fewest jobs in three years in April.
Meanwhile, the auto boom is starting to peter out, while the wildly inflated commercial real estate market is about to roll over. We’re also seeing all those bubbles in IPOs, tech unicorn-land, M&A, and debt-funded stock buybacks simultaneously deflate.
Now take a look at this chart I shared with readers of my Safe Money Report a few months ago. It shows where I believed we were in the economic cycle at the time, and it tells you what you typically see happening in a late-cycle environment.
"Growth moderating. Credit tightens. Earnings under pressure. Inventories grow; sales growth falls." That sounds pretty similar to what I just outlined, right?
As for China, sorry but nothing is fixed there. Instead, the country just unleashed a few weeks of epic stimulus spending and easy money. Some estimates peg the money flood at an all-time record of around $1 trillion in the first quarter alone.
What did China get for all that dough? A brief surge in asset prices globally, a few more months of reckless real estate activity at home, and the biggest surge in history in commodity speculation by Chinese retail "investors"/gamblers. Even that is now starting to peter out.
[Read More – The Consequences of Reckless Lending – Mike Larson]
As a result, the cyclical stock rally is starting to give way. That helped drive the Dow Industrials from a peak of almost 18,200 in mid-April to around 17,600 earlier this week. But I don’t think cyclicals are worth buying after that correction. Not by a long shot. I believe they have much more room to fall.
That’s why I continue to maintain very high levels of cash, and why I continue to focus on "safety stocks" that offer generous yields, lower volatility, and less economic sensitivity.
My favorite utility and consumer staples names are powering right back after a recent dip, for instance. You can get those recommendations in my Safe Money Report by clicking here.
Want to get more aggressive? Take advantage of these periodic bouts of wild Wall Street optimism to add new positions that make money from downside moves? Great.
I just helped my All Weather Trader subscribers bag a couple rounds of solid double-digit gains by targeting insanely overvalued cyclicals that got puffed up by the China-led fake out. You can get recommendations like those by signing up here.
If you’re not ready to take either of those steps, no worries. Just remember that we experienced the biggest easy money/easy credit boom ever from 2009-2015 … and that those days are over. The cycle has turned, and the consequences are spreading out in concentric circles.
So this is no time to be complacent about risk. It’s the time to gird for tougher conditions in all kinds of markets.
Until next time,
Mike Larson
P.S. Your $29 reward expires TODAY at 5:00 PM Eastern Time!
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Recommended Articles by Mike Larson:
Mike Larson graduated from Boston University with a B.S. degree in Journalism and a B.A. degree in English in 1998, and went to work for Bankrate.com. There, he learned the mortgage and interest rates markets inside and out. Mike then joined Weiss Research in 2001. He is the editor of Safe Money Report. He is often quoted by the Washington Post, Reuters, Dow Jones Newswires, Orlando Sentinel, Palm Beach Post and Sun-Sentinel, and he has appeared on CNN, Bloomberg Television and CNBC.
{ 17 comments }
Your colleague larry is talking about sharp fall in gold price and then upward move..kent moor is talkng about high oil prices…mr dent is very bearish on all class of assets…i m confused..pl clarify
Everyone is entitled to his/her own opinion. No two people agree about everything.
This column does a GREAT job of laying out the economic fundamentals and status of the underpinnings of the Market and Economies. However it tends to be overly pessimistic and cautious at times. While the pessimism was being preached and followed the last few months, big gains and profits were made in the Market. I for one prospered at two intervals and exited profits intact prior to falls. All of the gloom and doom is still hovering and about to land (as your commentary aptly points out) but traders have to play and be responsible for their own strategies and not always follow the mass sentiment. If you say something long enough (market wise) it will eventually happen, profits or losses, the skill is in the playing of the game as it flows.
So how can we make money on US real estate and being from Canada how can we profit from Canadian gold mining companies. Thanks
Buy low, sell high. Simplistic, maybe, but it’s the only way.
sounds too easy, but absolutely stick with the fundamentals. common sense is in short supply.
Just read about the Sharia Gold standard. 2 Trillion in assets invested in gold by Islam expected to double by 2020 will send gold prices soaring. Fact or Fiction?
Saudis may sell much of that $750Billion of Treasuries they hold, and put it into gold. Russians have already done so with their Treasury holdings. Chinese next? Dollar seems on the way down. Mike already recommends a foreign ETF. Maybe a way to go.
if the saudis try and sell their treasuries, we may have to put a hold on their assets whilst we sue them for 911. i think its called green mail.
‘Just read that 2/3 of S&P500 stocks had reported a collective decline in earnings of 7.6% by 4/29. Looking for 4.6% decline when all reports are in. This will be the fourth quarter of earnings declines in a row. Last time that happened was in 2008-09. Markets have resisted falling in trace, so when they do fall it could be a hum-dinger.
Chuck, agreed! It does appear that the economic storm clouds are gathering, and like the weather, the longer it stays sunny and warm here, the worse the storm could be once it gets started in earnest!!
However, MANY are, and have been, forecasting this “correction.” Usually, real corrections don’t happen when “everybody” is expecting them……
Buy low and sell high? That’s all relative, and only hindsight tells what’s high or low.
it’s always a humdinger, chuck. and it’s always a buying opportunity. bring it on!!!
why not everyone just Let stocks market to crash deep and hard now .
It will be good to see multiple crashes :
$SPX crash to 1700 – 1600 – 1500….
and
Dow Jones crash to 14,000 – 12,000 – 10,000 , etc.
I wish they will crash deep faster , so we can buy the dip cheap .
Let there be multiple crashes sooner .
As you can see from Mike’s chart, it is all about timing. Yes we are in the “Late” session of expansion. Normally, I should say we are getting to be very late here; but with the Brexit vote and the US elections still coming up this year, every effort is being made to kick the fine line between “Expansion” and “Contraction” down the road. Treating current Expansion to continue for much longer is putting a lot of faith on the powers that be. Do they really have enough nets to contain every black swan for much longer?
For what it is worth. Here is my projection as to when the markets will really spell Contraction:
Between 5 to 8 July 2016.
the dow and s&p pattern looks to be a stalemate between the shorts & longs or bulls & bears – and equal number of both and definitely a struggle going on there. i can’t find a pattern like this ever happening before. we’re like a car engine stuck on tdc (top dead center). just a nudge will do it.
I heard that the US will be swapping over to digital currency in mid June this year, in a way to handle the run on the dollar, and while OPEC is meeting. Could there be any truth to this and what could be the resulting outcomes