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Investing: Trends and Cycles
New York: June 14, 2004
By

Is the economy strengthening or about to weaken? How do you place your bets in an economy such as this one? When should you be buying dividend-paying stocks and when should you be buying growth stocks? Should you analyze the fundamentals of individual stocks or should you spend your time trying to understand the economic cycle and which companies might benefit the most from changes in the economy?

Now is a pretty good time to be thinking about adopting a more defensive strategy for your portfolio, since the Chicago Purchasing Managers’ Index, Philadelphia Fed and the Institute of Supply Management (ISM) are all hovering near their historic highs. When economic activity reaches these plateaus (as measured by the Chicago PMI, Philly Fed and ISM numbers) it means that there is usually a significant transition of the leadership groups within the stock market. This leadership transition occurs both within the various economic sectors that represent the stock market and across all ten economic sectors of the stock market. With new historic highs being reached in the various economic barometers, it might well be time to start to think about who the likely winners and losers might be in your portfolio as the market will likely anoint a new group of market leaders and laggards as it transitions to another phase.

It is widely known on Wall Street that certain stocks are cyclical in nature — meaning they tend to rise and fall in lock step with the business cycle. Cyclical stocks such as auto companies tend to do well when the economy starts to recover and begin to weaken when the overall economy turns down. In general, cyclical stocks (such as the equities of car manufacturers) follow the business cycle closely because the buyers of the end use products (cars) tend to exercise discretion when it comes to their purchasing decisions. If you feel that your own personal economic situation is improving, you might very well go out and buy a car. On the other hand, if things are looking a little tight around your place, you might just take a pass on a new automobile. Non-cyclical stocks are ones that are generally not impacted by the overall strength of the economy. Coca-Cola is an example of a product (and a company) that is a non-cyclical because even in a rising interest rate environment, people will still need to buy food.

The strength of the business cycle can be represented by the strength of overall indicators of economic growth such as the Institute of Supply Management's index and the Chicago Purchasing Managers’ Index. With these numbers approaching their historic highs, the likelihood of cyclical stocks continuing their upward path is unlikely.

Sophisticated analysis can determine the relationship and the relative strength of the relationship of certain stocks to the level of overall economic activity. Some stocks that closely follow the economic cycle and with the economic indicators hovering near twenty year highs, these are stocks that you might want to sell. Other stocks that tend to do better when the overall economy is heading down are ones which you might want to switch into. Some stocks that are tied to the economic cycle include AES Corp., National Semiconductor, Costco, U.S. Steel and American Express. Stocks that have historically done better when the economy is weakening include Waste Management, Allstate and Sigma-Aldrich. By following the economic cycle and selling cyclical stocks at the top of the cycle and buying defensive names as the cycle turns can be an extremely profitable strategy.

 

Report on Money is a division of The McConnell Group an investment research and management consulting firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but The McConnell Group makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson did not maintain an investment position in any of the securities mentioned in this article.


StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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