Plotlines: “Early-cycle” stocks outperforming so far this year

April 2, 2008


A basket of stocks meant to send the first smoke signals of broader recovery is on a tear. Will the broader market follow?

The Merrill Lynch early cycle index, made up of auto makers, home builders, retailers and building materials companies, is up 6.8 percent this week and 7.25 percent so far this year. To compare, the benchmark S&P 500 is off 6.5 percent in 2008. (All of the XE components are in the S&P 500). Within the XE, there have have been big comebacks in home builders – Pulte Homes

(+51.33% ytd) and KB Home (+32.1% ytd). Two retailers also have been top performers: TJX (+19.8% ytd) and Wal-Mart (+14.7% ytd). While the S&P kicked off the second quarter on Tuesday with a 3.6 percent rally, the XE trumped it with a 4.2 percent gain. The XE helped lead the charge out of the last recession, which ran from late winter through mid-autumn 2001. The index gained 44 percent in the period from late September 2001 through early March 2002. That was double the S&P 500’s rise in the same period.

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The mini-rally we are currently seeing in the market is based on the assumption that the economy will make a recovery in the second half of the year, something we hear touted in the media on a daily basis. That idea is based on the presumed effect of the monetary and fiscal stimulus. However, the fiscal package will likely be too little too late, as it is usually the case with fiscal policy. More importantly, the monetary policy, which has been highly effective in the past, will not have the desired effect this time. The significant rate cuts by the FED do not translate into more cheap credit in the economy, as banks refuse to lend and keep hoarding all the cash they can get in order to prop up their balance sheets, faced with the prospect of new waves of writedowns to come. The credit market will tell you when better days are ahead, and it is not yet happening. Here is the way I look at it: if you compare the economy with a living organism, then credit is the blood of the economy, and the banks are the heart pumping that credit through the economy. From this perspective, the current credit crunch is the equivalent of the economy having a heart attack: the banks are no longer pumping credit through the economy. And so far, we are a long way from making a recovery. In fact, we have yet to get the banks to start pumping again. Meanwhile, unemployment is increasing, consumer spending decreasing, and business spending will take a big hit in the current quarter as the effects of the credit crunch ripple through the economy. All this as home prices continue to slide in the background. All things considered, it seems highly unlikely that we will see a recovery in the second half of 2008.

Posted by Andre Taiakin | Report as abusive

FT Alphaville reported yesterday that monoline uberbear Bill Ackman’s Pershing Square IV fund is long TGT to the tune of $2 billion in a 10-year lockup. Obviously, there is a good argument that the US economy will weather the credit bubble shake out and start grow again sommeday. The question is when. My best guess is that short covering and margin calls explain the upward spurt in shares. I agree with Andre. Watch credit, write-downs, creditworthiness and consumer lending. I wouldn’t be surprised if another major player had to be rescued with public money or bonds, thinking of Countrywide and WaMu in particular.

Posted by Alan von Altendorf | Report as abusive

A montly chart of the homebuilders reveals that a bottoming is occurring, but before a meaningful trend reversal occurs, it may take us into 2010. Project the RSI 14 on a monthly chart to estimate how long it will take to cross up on the 50% axis, and you will see 2010.

Posted by Richard | Report as abusive

So far, the provisions announced by the major banks does not offer us very clear insights on their credit card portfolio credit performance (as these banks often have large portfolios of mortgages, credit cards, derviatives, etc). The biggest mononline credit card player is Capital-One Finance, which is due to announce its results 2 weeks from now. From their results – delinquency of their credit card portfolio, it will offer investors clearer insights into the current situation. Not only would one be able to evaluate the sufficiency of provisions by the other major financial institutions; one would also be able to analyse the avaliability of credits to consumer – and consumer spendings.

Posted by Michael Wei | Report as abusive

The market is a living organism, ans as it turns out credit was one of it’s main sources of energy. This effect can be seen when there is a slight freeze or reduction in credit liquidity, many businesses rely on it to function.

Of course the ratio of debt to real money in the world continues to increase, so the system is propped up fictionally more and more.

Posted by Stock | Report as abusive