A COMPARISON OF ECONOMICALLY-SENSITIVE CYCLICAL STOCKS TO CONSUMER STAPLES TELLS US A LOT ABOUT THE STRENGTH OF THE MARKET AND ECONOMY -- THE TREND IS STILL WEAK

CYCLICAL STOCKS CONTINUE TO UNDERFORM ... One of the easiest ways to measure the strength or weakness of the stock market and economy is to compare the relative performance of economically-sensitive stocks (cyclicals) to economically-resistant stocks. The logic is very simple. In an up market (and a rising economy), cyclical stocks do better. In a falling market (and a weakening economy) consumer staples do better. I'm showing two different ways to measure their relative performance. Chart 1 compares Morgan Stanley Cyclical Index (red line) and the Morgan Stanley Consumer Index (blue line) to the S&P 500 (flat line) since 2003. The red and blue lines are actually relative strength ratios. From the time the last bull market started in the spring of 2003 to the middle of 2007, economically- sensitive cyclical stocks (autos, metals, papers, machinery, chemicals and transportation) rose faster than the S&P 500, while defensive consumer staples (beverages, food, pharmaceuticals, tobacco, and personal products) rose much slower. In the middle of 2007, however, the two indexes reversed roles. Cyclicals started to underperform while consumer staples started outperforming (see arrows). So far, there's no sign of that bearish alignment changing direction.

Chart 1

Chart 2

MORE DIRECT COMPARISON ... A more direct way to compare the two indexes is by a simple ratio of the two. Chart 2 is a ratio of the MS Cyclical Index divided by the Consumer Index. The direction of that line tells us two things. The first is which of the two groups we want to be invested in. The second is the likely direction of the stock market and economy. In the last bear market from 2000 to the end of 2002, the falling ratio meant that consumer staples were the better place to be. The falling ratio was also symptomatic of a weak stock market and economy. The ratio turned up during the first half of 2003 which signalled an important turn to the upside for stocks and the economy. The rising ratio also favored investment in economically-sensitive stocks. The drop in the ratio starting in mid-2007 signalled a switch out of cyclicals and into consumer staples. It also told us that the stock market and the economy were in trouble. One of the things to look for at a market bottom is an upturn in the cyclicals/staples ratio. So far, there's no sign of that.

RISING DOLLAR KEEPS COMMODITIES UNDER PRESSURE ... Commodity prices continue to fall along with global stocks. Commodities are also being hurt by a rising dollar and falling foreign currencies. Charts 3 and 4 show a close correlation between the Euro (Chart 3) and the DB Commodities Tracking Index (DBC). Both fell again today. Commodity-related stocks were among today's biggest losers as were financials and consumer discretionary stocks.

Chart 3

Chart 4

FINANCIALS AND DISCRETIONARY STOCKS WEAKEN ... Financial and consumer discretionary stocks led the market lower today. Today's drop pushed the Financials SPDR (XLF) dangerously close to its October lows (Chart 5). Its relative strength line has already undercut that earlier level. Chart 6 shows the Consumer Discretionary SPDR (XLY) also losing 3% today. Its relative strength line continues to weaken. The biggest loser in the XLY was General Motors (-23%) which fell to the lowest level since 1942. Other notable losers were in the retail and homebuilding groups. That kept the rest of the market on the defensive.

Chart 5

Chart 6

S&P 500 CONTINUES TO TRADE SIDEWAYS ... The S&P 500 lost 20 points today (-2.2%). The hourly bars in Chart 7 show the S&P still locked in trading range between its October intra-day peak at 1044 and its October intra-day low at 839. The two converging trendines have the look of a "triangle". I've explained before that a triangle is normally a continuation pattern which, in a downtrend, favors an eventual drop to new lows. A close over the early November peak at 1007 is necessary to negate that bearish pattern. A close below 845 would be a negative sign.

Chart 7