Uncategorized, Weekly Update

Late-Cycle Sectors Beginning to Shine

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Published January 5, 2018


Over the past year, there have been numerous articles telling us that the U.S. economy is entering the “late-cycle” phase, a period of about 18 months characterized by rising inflation (and therefore rising interest rates), higher commodity prices, and positive though waning economic growth.

This article from Simon Constable in the Wall Street Journal published nine months ago in April 2017 is an example:

The term “late-cycle stocks” is being frequently used once again by investment professionals. The term refers to the types of stocks that tend to outperform later in the business cycle, when the use of resources and labor gets closer to full capacity and demand for materials such as copper, steel and energy tends to outpace supply.

“It is getting close to the eighth anniversary of economic expansion and we believe we are in the later stages of the U.S. economic cycle,” says Stephen Wood, chief market strategist at Russell Investments in New York. By historical standards, that’s a long expansion for the U.S., though not as long as the record 120-month expansion that occurred from March 1991 through March 2001, according to the National Bureau of Economic Research.

Late in the economic cycle, wages start to rise and inflation picks up. That’s already happening in the U.S., says Mr. Wood.

January saw the fastest increase in wages since the 2007-09 recession. The recently released GDP price index showed an annual inflation rate of 2% in the fourth quarter of 2016 versus 0.8% a year earlier.

The RJ/CRB Commodity Total Return Index, which tracks a basket of commodity prices, rose to 191 at the end of February from 161 a year earlier.

For stocks, this means that commodity producers, such as large mining companies and energy companies, could be poised for a run-up.

The table below is from the article. We’ve written the 103 on the table to bring it current from the April 2017 date of publication. The current expansion will easily move into 2nd place early in 2018.

At 94 months, the U.S. economic expansion ranks No. 3 since records began in 1854

So what has happened with the late-cycle stocks which were “poised for a run-up”?

They have indeed run up. But only in the past month with any notable outperformance. Chart 1 below compares materials and energy stocks with the S&P 500.

Chart 1: Commodity-related stocks begin to shine

Commodity-related stocks begin to shine

Interest rates are rising. Commodity prices are rising. Inflation, which is primarily driven by wage growth, is heating up a bit. The market increasingly acts as if it believes we are in the latter phase of the economic cycle. Will this economic expansion rise to be number 1, eclipsing the dot.com bull market of the late 1990s? One difference is that we have a global economy that is firing on all cylinders right now, in a rare synchronized expansion. What will cause this freight train of a stock market to come off its tracks? Something will. Markets always overshoot. We are thankful we have an investment approach that will be prepared to exit when that time comes and look to profit from the inevitable market decline, which is getting closer with every passing week.

Market Update

Contrary to some expectations that the new year would bring a round of profit-taking, stock investors burst into 2018 with the bulls stampeding. The Nasdaq, coming off a powerful 2017 gain, blasted upward +1.5% to begin the new year. There was no news other than the opening of the markets. That was all it took! The buying continued Wednesday with oil prices pushing further above $60/barrel to a 3+ year high. Stocks added another +0.6% with the Nasdaq once again leading the charge. This despite a notable downdraft in shares of Intel (INTC) on reports of design problems in some of their products. Strong gains overseas and strength in financial shares kept the 2018 buying party alive Thursday with the S&P 500 lifting +0.4%. Friday’s monthly jobs report underwhelmed with jobs coming in well below prior readings perhaps reflecting that the market is nearing full employment. Nevertheless, stocks kept 2018 perfect with a +0.7% rise and another strong day internationally.

After a couple of flat weeks to end 2017, stocks blasted higher to begin the new year. The S&P 500 (SPY) gained +2.46% while the Nasdaq 100 (QQQ) surged +3.95%. Small-caps (IWM) returned to underperforming but still managed a +1.53% rise.

Warm wishes and until next week.

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