Daily Trend Watch
July 29, 2003
A Picture Of A Recovery, Part 1
Several weeks ago we first started looking at what a 'real' economic recovery would look like. The June 12th TrendWatch 'Food For Thought' explored the idea that cyclical stocks and small cap stocks would lead such a recovery. At that point in time, the cyclicals and small-caps were certainly outperforming the market. Today we'd like to check up on the same indexes, to see if they've retained their top spot in terms of percent returns since March's lows.
For complete details about why cyclicals and small caps are supposed to lead a recovery, be sure to reread the June 12th TrendWatch. For now, suffice it so to say that as the economy starts to strengthen again, it's the cyclical stocks and small caps that look attractive. Why is this? These are the companies that have the most to gain from an economic boom. If the economy improves, then personal incomes and corporate profits will too. A cyclical company such as Home Depot directly benefits from all the home improvements that were previously put on hold. Corporations start spending on tech again, perhaps buying software developed by a small, nimble company.
Conversely, the non-cyclicals don't have as much (if anything) to gain from an economic boom, and thus become less attractive. What happens then? Investors rotate out of non-cyclicals and into cyclicals. This of course drives the prices of cyclicals up, while driving down the price of the non-cyclicals.
When we last looked in June, The Dow Jones Cyclical Index was up 29.1% above March's lows. The Dow Small Cap Index was up 28.6% for the same timeframe. By comparison, the Dow Jones Average was up only 18.6% from March's low, while the Dow Jones Non-Cyclical Index was only up by 17.3%. At that point, one could certainly make a strong case for an economic recovery. But has anything changed since then?
Generally speaking, the cyclicals and the small-caps are still outperforming the overall market. In fact, the non-cyclicals have actually fallen a bit since our last look at these numbers. This bodes well for the recovery a lot of pundits say is already underway.
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As we said in June, while this is what an economic recovery would look like, this is not necessarily evidence that we are truly recovering just yet. Why not? It's easy to be bullish when stocks are rising, but we'll want to see this relative outperformance sustained when stocks begin to pull back. Our concern is that these small caps and cyclicals will be the first and fastest to fall, which would of course negate any recovery hopes based on this model. The bottom line is this - stocks haven't been truly tested since March. We'll reserve judgement until these sectors have proven (or fail to prove) that they have staying power, but these are definitely charts worth watching.
Today was a technical look at an economic recovery. This coming Thursday, we'll revisit the economic and corporate fundamentals of a recovery, focusing on an appropriate P/E ratio.
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ABOUT PRICE HEADLEY red space Price Headley is the founder and chief analyst of BigTrends.com, which provides daily stock and options recommendations and education. Timer Digest recognized Price and BigTrends.com among the Top 10 stock market timers for 2000. Price has been widely quoted by Barron's, CNBC, The Wall Street Journal and USA Today. Price is also the author of the new book, Big Trends in Trading: Strategies to Master Major Market Moves.
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