The Cyclical Trade Breaks Down

After having a tremendous run, the cyclical trade is breaking down in a big way. This will most likely be the seventh day in a row that cyclical stocks have underperformed the S&P 500.

Smaller stocks have a semi-strong relationship to cyclical stocks and we saw that the Russell 2000 Index got creamed yesterday, falling by more than 2.5%.

Here’s a look at the Morgan Stanley Cyclical Index (^CYC) divided by the S&P 500 (blue line, left scale), along with the Russell 2000 (^RUT) divided by the S&P 500 (black line, right scale):

The cyclicals have had a great rally for nearly two years, so taking some time to rest is to be expected. I don’t know yet if this is merely a pause or if it’s the beginning of a long-term downtrend. The thing about cyclicals is that the market itself is cyclical. This means that cyclicals generally outperform a rising market and underperform a falling one. It’s a double-whammy effect.

Our Buy List doesn’t have a strong cyclical component. In fact, one of the reasons why I added Ford (F) was to beef up our exposure to cyclicals. Although Ford has gotten hit the past two days, I’m still glad I added it.

Posted by on January 20th, 2011 at 12:40 pm


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