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Time To Get Cyclical?

|Includes:Bank of America Corporation (BAC), GLW, HPQ, JCI, VLO

The recent market rally has left many pondering why their accounts have not gone up. The US index's are sitting close to multi-year highs, but over 50% of the equity universe is closer to their lows, then highs.

Cyclical stocks such as Financials, Materials, Energy, Industrials and Technology (its hard to believe) have all been left by the way-side in the current market rally. With the exception of a few Blue chip names, the remainder of these sectors are down. In the Energy world, not only have companies not kept up, but they are all down. HAL is down almost 50% from its post recession high (2011). They are not alone, most drillers and oil servicing industry are down. Global Oil Conglomerates are trading at ridiculously low prices. Until recently, the refiners were all down as well. Valero, a true cyclical stock all of a sudden is going straight up and is now up 45% over the past 13 weeks. Being a prior owner I have always known this stock to be undervalued. US demand for gas has been weak and the stock depressed as a result. There are many reasons for Valero to be going up such as their ability to refine lower grades of crude, or the fact that a few refineries went off-line. Valero also trends with the crack spread (difference between Brent and WTI). As the spread widens, Valero goes up and vice versa.

That brings be to my question: If Valero is up this much, shouldn't the rest of oil start to follow? If oil is going up, that would mean World economies are doing better then what is reported! With housing showing continued signs of recovery, as the most recent report showed prices going up for what is now 14 consecutive months, shouldn't the banks that are tied most to the housing market be going up as well? If prices are going up, that means their is buying activity and lending. Lending activity has been on the rise

The market is up because a few companies. Apple alone added 200 Billion in market Cap. Now that is 15 Valero's. So Valero could of gone to zero along with a dozen other companies and the S&P would of still been up. The Dow is 30 companies and the companies with the highest price have been rallying the most, which is quite deceptive, because if IBM increases its market cap at the same rate that Bank of America decreases, then in the real world it would cancel itself out. However, the DOW would/is showing a gain since it weights returns based upon price. IBM at $195 has a lot more influence then BAC price of $8. The S&P and Nasdaq can be summed up with one word, Apple for the reasons mentioned above. While a certain few other have gone up recently such as Intel and MSFT, the truth is most have not and that with these increases, MSFT and INTC are no where near their decade highs. Texas Instruments hasn't gone up in a decade. HPQ is flirting with the same price it was 16 years ago. Cisco has bought almost a third of the outstanding shares, has 48 Billion in cash and just doubled its dividend, yet it is still at the same price range that it was 14 years ago and at the low of its ten year range.

The bluest of blue chip and most defensive (also largest) companies have led this rally. Altria (Tobacco/Alcohol) has been on fire. Drug stocks up and as we all know, they are very big companies. Home Depot on roll, almost doubling in the past year alone! Early signs of a housing recovery?

What does all this mean? The markets are up because of defensive dividend paying stocks, which are also the largest companies in the US. The market really is down. If it were up, why would people be willing to buy Sovereign debt from the US, Germany, Austria, Japan, Swiss at negative inflation adjusted yields and many cases negative yields! While negative yields has not occurred here yet, it has in Austria and Norway?Swiss (one of those two) Germany reached yields close to zero and for the US, Treasuries barely pays the rate of inflation on a 30 year yield. With all this fear reaching unprecedented levels, at some point the market will turn back in favor of cyclicals. As we know, this will happen prior to any actual recovery and it is justified as most these stocks are trading at record low valuations. Even with no growth, most are still growing earnings and sporting single digit P/E's. Many are initiating and/or raising dividends. I am starting to see signs of this in stocks like Valero, Corning really jumped today and Johnson Controls has been showing real signs of strength of late. Though while JCI may be up recently (bottomed around $24 and is now at $27.33), its still a long way from its 2011 high of $42.

If you believe the we are approaching that corner, then Energy, Materials, many industrials and technology names will offer tremendous up-side potential such as a Johnson Control that would need to go up 50% to reach its 2011 high or a Bank of America at 150% to do the same!

Disclosure: I am long GLW, JCI, BAC, INTC.