Early-Cycle Stocks Begin to Provide Leadership
Stock market players are asking the same question that many unhappy voters have posed this year: Where are the real leaders?
In Wall Street’s case, however, we actually may have some new candidates.
Last week’s market surge, which carried the Dow Jones industrial average up a net 108.07 points to Friday’s close of 3,393.78, was fueled by heavy buying of home builders, clothing retailers, energy-related companies and industrial firms.
Those groups often surge at the start of economic recoveries, as investors search for companies whose products or services should see a fast pickup in demand as business conditions improve.
If this feels like deja vu, it should: Many of the same stock groups were the market leaders early in the year, after the Federal Reserve slashed interest rates and the economy indeed appeared ready to roar.
By June, however, worries about a new economic slowdown began to weigh on industrial issues in particular. By early July, many of those stocks were in full-scale retreat.
Now, with the latest declines in long-term interest rates, more investors are taking the view that summer weakness in the economy will give way to fall strength. So they’re flocking back to the companies that typically gain at the start of a recovery.
Stu Roberts, manager of the Montgomery Small-Cap stock mutual fund in Denver, notes that you don’t necessarily have to believe that the economy is permanently on track to buy the so-called early-cycle stocks.
The point, he says, is that as more investors shift from heavy pessimism about the economy to a semblance of optimism, they come back to the same stocks. If you’re a trader, “you can play this ‘early-cycle’ economy theme again and again,” Roberts says--if the recovery continues to ebb and flow over the next year as some experts expect.
Lately, Roberts has been buying shares of California home builders such as Kaufman & Broad ($15.375 Friday, NYSE) and Presley Cos. ($8.50, NYSE), figuring they’ll enjoy an increase in business thanks to the recent steep slide in mortgage rates.
Some beaten-down retailers also have caught Roberts’ eye, including Anaheim-based discounter ClothesTime, which rose 62.5 cents to $9.625 Friday but remains well below its yearly high of $13.25.
Jim Craig, manager of the Denver-based Janus Fund, also believes that many investors will jump back into early-cycle stocks in coming months. His fund has big bets on such names as Conrail ($88.25, NYSE), General Motors ($41.625, NYSE) and southeastern U.S. banking behemoth NationsBank ($46, NYSE).
Investors are looking for any excuse to buy back into those stocks, Craig says. He notes that shares of Du Pont rose sharply last week after the chemical giant reported better-than-expected second-quarter operating earnings, even though net earnings were penalized by a one-time charge.
Du Pont stock finished the week at $53.625 on the NYSE, up 9% from $49 a week earlier and near its 52-week high of $54.875.
New interest in Du Pont is partly a result of higher expectations for its Conoco energy unit in the second half of the year. Indeed, energy stocks--especially natural gas companies--were among the market’s strongest groups in July, as oil and gas prices have remained firm despite the weak economy.
Meanwhile, what about the favorite stocks of 1988-1991--the “growth” issues in health care, food production, tobacco and other supposed steady-demand industries?
Those stocks fell off the shelf early this year as industrial and other early-cycle companies came to the fore. Shares of big-name drug companies were especially hammered in the first six months as investors bailed out.
In June and earlier this month, though, many growth issues began to rebound. The drug group, for example, gained 6.7% in July, according to a tally by Smith Barney, Harris Upham & Co. Some growth-stock fans say July marked the beginning of the stocks’ Renaissance.
“I think there’s a bias redeveloping toward growth stocks because the economic indicators remain so (weak),” says Gordon Fines, senior portfolio manager at the IDS investment firm in Minneapolis. He figures that investors will at some point grow tired of waiting for industrial companies’ profits to blossom, and will return en masse to growth issues.
Janus Fund’s Craig doesn’t buy it. Consider how low interest rates have dropped this year, he says. Traditionally, sliding rates mean that investors are willing to pay much higher prices for growth stocks relative to their earnings per share, because 1) those earnings are expected to be dependable while 2) the drop in rates reduces the attractiveness of competing investments, such as bank CDs and bonds.
But the price-to-earnings multiples of the growth stocks haven’t risen, Craig notes. In fact, they’re still well below what they were earlier in the year. Though most drug companies were able to produce double-digit earnings growth in the first half of the year, for example, the drug stocks as a group remain 10.5% below their prices at the end of 1991--even after accounting for the July gain.
What that says, Craig believes, is that investors have simply lost their enthusiasm for those stocks, and it may be a long time before that enthusiasm returns. Instead, the revival of the early-cycle groups shows that investors still are seeking stocks of companies whose earnings gains should be much faster than the growth companies’ gains, if the economic recovery ever becomes airborne.
Newton Zinder, technical analyst at Shearson Lehman Bros. in New York, concurs that industrial stocks and financial-services issues make better bets now. “The growth issues will get periodic bounce-backs, but I think they’ll be no better than market performers” through 1992, he says. If anything, use the bounce-backs to take more profits in the growth group, he says.
Finding the Market’s New Leaders
Here are the stock groups that rose fastest in last week’s big rally, and the groups that rose the most for all of July. The week’s results, in particular, show a resurgence of stocks that have the most to gain if and when the economy begins to accelerate convincingly.
Best groups, last week
Group Gain Home builders +14.7% Clothing retailers +8.2% Building materials +7.2% Oil well services +7.2% Oil/gas drilling +6.5% Furniture/appliances +6.2% Auto makers +5.9% Truckers +5.9% Chemicals +5.6% Divers. health care +5.6% S&P; 500 index +2.9%
Best groups, July
Group Gain Home builders +20.5% Oil/gas drilling +13.9% Shoemakers +13.2% Hospital management +10.8% Natural gas +10.5% Office equipment +10.4% Cosmetics +8.5% Oil well services +8.2% Tobacco +7.8% Building materials +7.8% S&P; 500 index +3.9%
Weekly data July 23 to 30; monthly data through July 30
Source: Smith Barney, Harris Upham & Co., using S&P; industry groups
