The cheerleaders of the stock market are trying to get us to believe that the Market Cycle and Economic Cycle theory of sector rotation no longer exists. At least, this is my take.
Sector Rotation is the movement of money into various industry sectors as the stages of an economic cycle unfold. There is a normal and distinct pattern that the economy and stock market follows during periods of economic expansion and contraction.
For some reason, we are being lead to believe that the economy is going to sidestep the contraction phase, and go right back into expansion. I'll believe it when I see it.
Even the fed is saying that there is no evidence (other than a downturn in real estate) that we have experienced an economic slowdown. To believe we are just going to skip this phase of the economic cycle is at best naive.
Market & Economic Cycles:
Market Cycle in Four Stages
Markets move up and down just like the economy. For the purpose of this discussion, we will divide that cycle into four stages
Period 1: Market Bottom - Capitulation and panic selling creates new long-term lows.
Period 2: Bull Market - Sustained market rallies from the market bottom.
Period 3: Market Top - A bull market starts to flatten out in light of good news.
Period 4: Bear Market - This is the precursor to the next market bottom.
The September-October period is historically the weakest period for stocks. In 2006, this has not been the case. Since the stock market has basically ignored all its seasonal tendencies, does this mean the seasonally strong period for stocks (Late October-March) will also ignore its historical pattern?
Economic Cycle in Four Stages
Here is a list, in the same order as above, of four basic stages of the economic cycle, and some associated telltale signs - again, keep in mind that these usually trail the market cycle by a few months.
Period 1: Full Recession - Businesses struggling, unemployment peaking, consumer expectations bottoming, interest rates falling, yield curve is normal. -Best Sectors: Cyclicals and Transports (beginning), Technology, Industrials (fading)
Period 2: Early Recovery- Consumer expectations rising, interest rates bottoming, industrial production growing, and yield curve is getting steeper.- Best Sectors: Industrials (beginning), Basic Materials, and Energy (fading)
Period 3: Late Recovery - Consumer expectations begin to decline, interest rates are rising, and yield curve is flattening. - Best Sectors: Energy (beginning), Staples, Services (fading)
Period 4: Early Recession - Consumer expectations at their worst, interest rates peaking, industrial production is falling, yield curve is flat.- Best Sectors: Services (beginning), Utilities, Cyclicals and Transports (fading)
The bullish market calls of late are advising investors to buy cyclicals and technology. As you can see in Period 1 above, cyclicals and technology are to be bought during a period of "Full Recession." Are we in a "Full Recession" yet? I don't think so.
The call to buy cyclicals should occur during a period of "Early Recession." We may be approaching an "Early Recession" but still have a ways to go. Technology on the other hand should be bought during a period of "Full Recession". We are not even close to this period yet so any purchase of technology here is a gamble.
Once again, it looks as if some market mavens believe we are going to go from an economic expansion, back into another economic expansion, and skip right over an economic contraction.
If this happens, look for the Fed to jump in several more times until its sees signs of an economic contraction.
