Don’t Get Sucked In By The Cyclical Stock Fake Out

bearbull1Mike Larson:  Cyclical stocks. The term refers to companies with substantial sensitivity to the economic cycle.

When the world (or U.S.) economy is just coming out of a slump or recession, they’re a screaming buy. All the excesses of the previous expansion have been wrung out, leaving them dirt cheap and primed for an acceleration in sales and earnings.

But at or just past the peak of the economic and credit cycle … when you’re only heading toward or into recession … cyclicals can crush your portfolio. Their earnings and sales tank, and their share prices follow right alongside.

I’m bringing this up now because we’ve just seen one of the biggest “Fake Out” rallies in cyclicals I can remember. Stocks with exposure to everything from transportation to chemicals to materials to construction to finance jumped between mid-February and mid-April.

The rationale on Wall Street? China is “fixed,” the U.S. is doing fine, so get in there and buy, buy, BUY! Not to put too fine a point on it, but I think that’s just plain nuts.

For starters, the U.S. economy is only tumbling toward recession at this point, rather than coming out of it. GDP growth fell to 0.5% in the first quarter, the lowest in two years. But we haven’t even officially dipped into negative territory yet.

I believe that’s coming next, given the lousy figures we’ve gotten on retail sales, durable goods, bank lending standards, and confidence. Then earlier this week, ADP reported that the U.S. economy created the fewest jobs in three years in April.

Meanwhile, the auto boom is starting to peter out, while the wildly inflated commercial real estate market is about to roll over. We’re also seeing all those bubbles in IPOs, tech unicorn-land, M&A, and debt-funded stock buybacks simultaneously deflate.

Now take a look at this chart I shared with readers of my Safe Money Report a few months ago. It shows where I believed we were in the economic cycle at the time, and it tells you what you typically see happening in a late-cycle environment.

“Growth moderating. Credit tightens. Earnings under pressure. Inventories grow; sales growth falls.” That sounds pretty similar to what I just outlined, right?

Click image for larger view

As for China, sorry but nothing is fixed there. Instead, the country just unleashed a few weeks of epic stimulus spending and easy money. Some estimates peg the money flood at an all-time record of around $1 trillion in the first quarter alone.

What did China get for all that dough? A brief surge in asset prices globally, a few more months of reckless real estate activity at home, and the biggest surge in history in commodity speculation by Chinese retail “investors”/gamblers. Even that is now starting to peter out.

As a result, the cyclical stock rally is starting to give way. That helped drive the Dow Industrials from a peak of almost 18,200 in mid-April to around 17,600 earlier this week. But I don’t think cyclicals are worth buying after that correction. Not by a long shot. I believe they have much more room to fall.

That’s why I continue to maintain very high levels of cash, and why I continue to focus on “safety stocks” that offer generous yields, lower volatility, and less economic sensitivity.

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