When to rotate into cyclicals? NOW!

I’ve been preaching for decades (and discussed in both my books ad nauseum) that the right thing to be doing at any point in time is the exact opposite of what everyone else is doing.  If it’s a difficult thing to do it will probably work.

A very smart if somewhat younger portfolio manager (Joseph) asked me this question recently:

“Hi Mr. Spooner, what indicators do you look at when trying to assess the potential for a rotation into cyclicals?”

I was reluctant earlier in the Spring to jump on sectors that are especially sensitive to the global economy. Why? What was everyone else doing?

The Canadian exchange-traded fund industry continues to blossom. By the end of the first quarter of 2012, ETF assets grew to about $49.1 billion, expanding 13.5% for the quarter. More important than the absolute growth numbers, however, is the fact that the industry’s growth was fuelled primarily by net new inflows from investors, not market appreciation.

If Canadian investors were buying, then U.S. investors were doing likewise times TEN. Money was chasing a rally instead of anticipating one and investors as always were very soon disappointed.

Truth be known, I expected interest rates to begin to rise and put a damper on the market. I was dead wrong about this, but it turns out I was wise (or rather, lucky) to avoid the stock market.

Back in a May blog I had suggested that holding on to a few growth stocks and cash would be the thing to do, so there’d be some money to invest during the summer slump.

In response to Joseph’s query, it seems pretty safe at this juncture to venture into the more economically sensitive sectors:

  • The housing market is improving, but employment in the U.S. still sucks (keeping a lid on U.S. interest rates for awhile yet no doubt).
  • Europe’s woes are keeping a lid on global interest rates (at least for countries with a credit rating).
  • When we have evidence (now) of an economic slowdown having taken place, rest assured it’s already history (since proof is only available after-the-fact).

Finally, there’s no better indicator for me than a change in direction of commodity pricing.  Oil prices rose in the late winter/early spring but did not quite get to the $120 WTI price I was predicting.  Prices plunged (as usual) beginning late in the springtime but suddenly look to be firming up along with other commodities.  When it comes to picking sectors and stocks, in my experience has been that the easiest place to begin my search is trying to find sectors that were hurt the most during the correction, and are already showing evidence of a rebound in prices.  Prices only respond because some of the smarter professional fund managers (buyers) want to get there first.

To save time, here is a snapshot of my own opinions about various S&P 500 sectors.  The logic behind my choices are simple: If they performed well (some growth areas did okay as I predicted…..Healthcare and Software but may now be tiring; defensives too like Consumer Staples and REITS were strong with the latter offering at least some yield) then I’d cash in some winning chips and bet on sectors that did terribly but are showing early signs of having turned the corner. The more sensitive to an improvement in the global economy the sectors and companies are, the better.

Cheers and ride safe!

About Mal Spooner

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.
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5 Responses to When to rotate into cyclicals? NOW!

  1. Bill Howe, Raymond James says:

    Thanks very much for your today blog. I have been getting the sense that the cyclicals should start behaving better, and was very pleased to read your notes. I recall you pounding the table in 2009 and I was wise to heed your advice.

    I am hoping that a fund company will show some sense and put you back into action!

    All the best and keep the common sense coming. I think it was Voltaire that said, “Common sense, isn’t very common!”

  2. Rick Konrad says:

    Thanks for the overview Mal.

    Love the sell recommendations on REITs but don’t let the yields fool ya. Just as an example, Simon Property Group (SPG) is generally perceived as one of the best shopping center operators around but as the largest market cap REIT, it now yields 2.5% on its distributions. With enterprise value currently just over $70 billion supported by trailing revenues of only $4.4 billion, investors are happily paying 16 times revenues for this real estate portfolio.
    Though one can argue that there is little forthcoming in terms of new mall supply, isn’t the reality that over the next ten years, consumers will become even less mall-centric as internet shopping will obsolete at least some of this distribution channel?
    The average rent/ square foot for SPG is $39.87 in Q1 2012 versus $38.72 two years ago, growing at less than 1.5% per annum.
    Great properties, great management, but what I think is an incredibly rich price.

    Couldn’t agree more with the shunned cyclicals. I agree with your notion of steels and some mining companies.

    Always great to see your contrarian and common sense views.

    • Mal Spooner says:

      Thanks for your insights Mr. Konrad. What is worth 16X revenues? Nothing I’d buy but then what do I know? The appetite for yield has made many interest-sensitive sectors overvalued by a wide margin, and there’ll be carnage when rates are ‘expected’ to rise (bond market will be the catalyst) which of course will be months before they actually do. Best wishes, Mal.

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