MARKET STARTS THE WEEK ON A STRONG NOTE -- THE FACT THAT ECONOMICALLY-SENSITIVE CYCLICAL STOCKS HAVE LED THE RALLY SINCE MARCH IS A POSITIVE SIGN FOR THE MARKET AND THE ECONOMY

CYCLICALS LEAD S&P 500 HIGHER... The stock market is starting the week on a strong note. Chart 1 shows the S&P 500 trading 2% higher and reaching the highest level in four months. Even more impressive is the action in the Morgan Stanley Cyclicals Index (CYC). Chart 2 shows that measure of economically-sensitive stocks having already cleared its January peak and in the process of testing its 200-day moving average. Its relative strength line (below chart) has been rising since early March and has also broken out to the upside. Why that's encouraging is because stocks in the CYC do better when investors are more optimistic on the stock market and the economy. The MS Consumer Index (CMR) has been a laggard since the March bottom (Chart 3). The CMR is composed of defensive stocks in beverages, food, drug, tobacco, and personal products. It's also rising, but not as fast as the S&P 500 or the CYC. It's helpful to compare those two competing indexes directly.

Chart 1

Chart 2

Chart 3

CYCLICALS TAKE NEW LEAD ... Chart 4 plots a ratio of the MS Cyclicals Index versus the MS Consumer Index. The rising blue line from early 2003 to mid-2007 is typical of bull market behavior as investors favor economically-sensitive stocks over defensive ones. The ratio peaked in mid-2007 (red arrow) and correctly signaled a rotation out of cyclicals and into defensive stocks just in time for the start of a bear market. The good news is that the CYC:CMR ratio is rising again. Chart 5 shows the ratio bottoming this March and breaking a down trendline drawn over the highs of last May and September. That's a good sign for the group and for the market as whole. The fact that investors have started to favor economically-sensitive stocks adds more support to the view that the market has probably hit a major bottom. The market is also hinting that the economy will probably hit bottom sometime during the second half of the year. One note of caution, however. The rally during the spring of 2008 also lasted from March to May before weakening. That's a subtle warning that it's usually not a good idea to turn too positive during the month of May when market pullbacks often start. A weaker dollar in Monday trading is also helping push most commodity prices higher and Treasury bonds lower. Leading market groups include economically-sensitive stocks like basic materials, energy, financials, semiconductors, and transports. The real test for the overall market will occur as the S&P 500 nears a test of its January peak.

Chart 4

Chart 5