Output & Profits Growth
A fast, efficient way to gauge what investors are looking toward regarding output and
profits growth is the relative strength of cyclical stocks. That's because the main swing
factor for both output and profits growth is how well cyclical companies will fare in the
environment ahead. The RS of the cyclicals sector reflects the collective expectation of
how strong or weak investors think the economy will be. $CYC Relative Strength
Market players have favored cyclical stocks since the summer of 2012 as they accepted
the idea that the Fed's new and large QE effort would lead to faster growth for the economy
and profits. There was noticeable hesitation over the first half of the current year on slower
economic progress and then initial concern about whether the Fed would cut back on QE.
But stronger economic data in recent months plus increased confidence that no cutback of
QE is imminent has returned the cyclicals to favor. The group is overbought now on an RS
basis but that condition can sometimes run on for awhile.
It is interesting to note that in a more mature economic recovery, cyclicals tend to be more
reliant on pricing power for positive earnings leverage than earlier in the cycle when rising
volume and a return of operational efficiency can carry the day. Keep this idea in mind since
the chart below also shows many investors see inflation and pricing power for business as
being rather tame ahead.
When inflation accelerates up, it generally starts in the commodities pits. As well, longer
duration bond prices can be very sensitive to rising inflation. Thus, a quick and easy way to
gather the wisdom of the markets regarding inflation potential is to look at the relative
strength of a commodities price index to a bond price measure, such as the 30 yr . Treasury.
CRB RS To 30 yr Treas.
The chart shows how this ratio anticipated the sharp deceleration of cyclical inflation pressure
from Sep. 2011 at 3.9% yr/yr down to 1.2% recently. The chart also indicates that QE from
the Fed has so far led to a conviction that only a very mild recovery of cyclical inflation
may lie ahead. So, the CRB / Treas. chart is less bullish on stronger pricing power for
business than is the $CYC / SPX chart. Interesting, as I say.
Normally, an acceleration of real output growth in the business sector comes with a decent
size uptick in pricing power. Let's see if commodities start to firm before long or if the
recent pick up in output is but transitory.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!