Talking Numbers

This could be a huge warning sign for the economy

This could be a huge warning sign for the economy

Are certain stocks giving a warning sign about the economy?

Everyone knows that stocks are up in the last five years. Leading the way have been cyclical stocks. Those are companies sensitive to the ups and downs of the economy like Disney, Ford, Netflix, and Amazon.

Since the bottom in the market five years ago this month, the market benchmark S&P 500 index is up 173%. Meanwhile, the Morgan Stanley Cyclical Index (CYC) is up 421%. Last year, while the S&P 500 was up 29%, the Cyclical index gained 40%.

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However, year-to-date, cyclicals have underperformed the general market and are the worst performing of all sectors. It may not be by much – the S&P 500 is flat while the Cyclical index is down 0.35% -- but according to Steve Cortes, founder of Veracruz TJM, things may get worse for cyclicals. And, that may be a bad sign for the rest of the economy.

"The consumer picture is deteriorating and at a pretty rapid clip," says Cortes. He is concerned with the performance of the two largest consumer credit card companies, Visa and MasterCard. Visa is down 3% in 2014 while MasterCard is down 12% so far this year.

"Consumer spending is by no means pricing in a cyclical upswing or a continued cyclical-type expansion," says Cortes of MasterCard's stock performance. Cortes notes that the relative performance of MasterCard versus the S&P 500 index as a whole traded closely with the Morgan Stanley Cyclical Index for much of the past year. However, since the start of February, when the general market and cyclicals rebounded, MasterCard has been underperforming both the S&P 500 and the Cyclical index. Cortes believes the two will trade together – but it may not be a rebound in MasterCard.

"Typically, MasterCard and cyclicals trade much more in tandem," says Cortes. "I think one of these is wrong – either the cyclicals are too elevated or consumer stocks are too depressed – and I think it's the former. Cyclicals are in trouble here."

"I don't think the global growth can justify the present levels of cyclicals. And I think the warning sign is what's going on in some key consumer stocks."

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However Prime Executions Chief Equity Strategist Steven Pytlar believes cyclicals may drop a little bit but, in the long-term, will continue along an upward trend line he sees as starting back after the European debt crisis in 2011.

"Since then, the trend has been exceptionally strong," says Pytlar. "Certainly, we can come back and retest that trend since we've been above it for so long in the CYC for the past several months. But, longer-term, there really aren't that many signals to suggest that trend is in danger."

Pytlar believes the Cyclicals index will remain intact because of the makeup of the index itself.

"The CYC encompasses all cyclical companies," says Pytlar."We might be seeing some rotation in early stage companies like retailers and consumer staples which are supposed to outperform at the beginning of an economic cycle. Towards the end, as the cycle matures, companies like industrials and materials can start to outperform. They're still cyclical, but they're just different cyclical companies outperforming and pushing that index higher."

To see the full discussion on cyclicals and what they mean for the economy with Cortes on the fundamentals and Pytlar on the technicals, watch the video above.

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