Can cyclicals maintain recent pace in the market?

OUTLOOK

May 09, 1999|By K.L. McQuaid

IN RECENT weeks, stocks of manufacturing companies and the stalwarts of American business have surged, taking the place of the high-technology firms that have been largely responsible for driving the raging bull stock market.

In fact, while the Morgan Stanley Cyclical Stock Index has risen 22 percent in the past month, technology stocks have been hammered, a reversal of the trend of the past three years.

What is fueling the stock increases of Caterpillar Inc., General Motors Corp. and others? Can the "cyclical" stocks maintain the pace they have set in the past month?

And what does the surge in cyclicals -- so named because they tend to do well in cycles, generally, when the economy runs full-throttle -- say about the economy?

Jim Hardesty

President, Hardesty Capital Management Inc., Baltimore

Technology stocks have really been performing at extraordinary levels, and their values have been consistently high. But as the normal rotation of the economy continues, cyclicals tend to perform better. Cyclical stocks are often referred to as "late-cycle" stocks. When business is running at full speed, companies begin to think about capital expenditures for equipment made by the likes of Caterpillar and other heavy equipment companies, paper companies, energy companies even. As the economy broadens, the economy needs more labor and more equipment to go with the labor, and those trends are all beneficial to late-cycle stocks.

A surprising contributor to their growth is the upturn in Asia. The recovery there has come from the Philippines, Hong Kong and China. Suddenly, now, there's a region of the world that had been absent capital for large expenditures. Asia's comeback into the fold of the global economy, if you will, has helped cyclical stocks.

Is the uptick in cyclical stocks long-lived? I think they have a ways to go, even though some of the gains have been dramatic -- Caterpillar is up 35 percent in the past month. Plus, these stocks have been so discounted for so long that now they suddenly seem incredibly cheap.

Alfred Goldman

Chief market strategist, A.G. Edward & Sons Inc., St. Louis

The cyclicals have come a long way in a short time, as evidenced by the Morgan Stanley index, and I think they are close to taking a normal pause to refresh themselves. After that, I believe the economy-sensitive stocks, which cyclicals are, have another couple of months of glory in the sun. They have been much maligned and out of favor in the past three years, I doubt that a month of popularity will be all they are entitled to.

The stock market tends to go into mood shifts and they don't end quickly. As part of the surge, there is growing confidence in both the domestic and foreign markets. But I don't think it's a long-term phenomenon. Eventually, the growth will go back to favoring long-term growth stocks, the same ones that were compelling the market forward until recently.

Barry B. Bannister

Principal, Legg Mason Wood Walker, Baltimore

The strength in cyclicals shows you can't look at companies' returns in a vacuum, you have to weigh them against the time horizon that the current price of their stock implies. That is the big argument within the market right now. Cyclical stocks did poorly from mid-1997 to the end of 1998, but now that they seem to be coming back, they have really reversed their difficulties. But on a larger scale of time, they really have a long way to go.

We're nearing, or at the point in the labor market, where it is so tight that the additional wages and benefits that are required may outpace productivity. Theoretically, when you get to the last worker available, that worker becomes very expensive. Tightness in the labor markets over time means the cycle is reaching the point of diminishing returns.

I think even if we overheat somewhat that that then gives Europe an opportunity to become a bigger trading partner at a time when a significant portion of most companies' earnings are derived from overseas, and the recovery there presents a case for a far more bullish approach for cyclicals than domestic slowing would be a bear for them.

Pub Date: 5/09/99

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