The Morgan Stanley Cyclical Index: Holding Clues To The Economy’s Next Move
Monday, April 20, 2009
by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report
The current stock market rally is one of the best I’ve seen in such a short period of time - especially in the midst of a recession, high unemployment, and a pretty nasty bear market.
Since the stock indexes bottomed out in March, the S&P 500 has risen by 30% from low to high.
Skip past that main headline, though - one the financial media loves to tout at the moment - and you’ll see that it might not be time to pop the champagne corks just yet.
From a technical standpoint, unless the indexes can now trigger weekly buy signals - which cannot occur for at least another 2-3 weeks - this could merely be a rally within a longer-term bear market. Both my colleague Marc Lichtenfeld and I believe this is the case.
For the time being, the S&P 500 still appears to be in the first wave of at least a three-wave advance, so I expect the rally has further to go. However, it’s put the indexes into overbought territory and I’d expect a wave-two correction, or consolidation to begin sooner rather than later.
Before I get to this week’s specific sector, I want to map out the current technical state of play on the S&P 500, so you know the best time to invest.
Plotting Resistance And The Best Time To Buy
As you can see on the weekly S&P 500 chart below, the first area of major intermediate-term resistance comes in around 970 points. This is the upper band on the trading channel (which is traced all the way back to the October 2007 high).
With the January swing high around 944 points, if the S&P 500 gets above the 900 level, I’d expect strong resistance in the 950-970 area.
If the S&P 500 manages to close above that upper trading band around 970, the next important resistance level comes in around the 1,007 area - the swing high back in November. If this happens 2-3 weeks from now, the 50-week moving average will be in the same vicinity.
In summary, the stock indexes could move a bit higher over the short-term, but the first leg of this rally is now getting “long in the tooth.” However, since many of the daily chart patterns still appear to be in the first wave of three-wave move higher, shorter-term traders should be looking to buy on the first decent pullback.
With that, let’s take a closer look at an individual sector…
The Morgan Stanley Cyclical Index Trounces the S&P 500
While a 30% rally in six weeks is impressive for the S&P 500, the Morgan Stanley Cyclical Index (^CYC) has trounced that performance lately.
Before we dig in, let me give you a quick and simple explanation of what “cyclical” means and the difference between cyclical and non-cyclical stocks…
The term “cyclical” basically refers to how highly correlated a company’s share price is to economic gyrations.
- Non-Cyclical: These stocks, which are also called defensive stocks, repeatedly outperform the market when economic growth slows. That’s because they’re still able to generate positive cash flow, regardless of economic fluctuations, as they produce or distribute essential goods and services such as food, power, water, and gas.
- Cyclical: On the other hand, cyclical companies are highly correlated to the economy and their sales largely depend on whether or not the economy is strong. Sales will typically thrive when people have extra income to spend on luxuries and will decline when the economy slumps.
The Bullish And Bearish Case For The Cyclical Index
Check out the daily chart of the Morgan Stanley Cyclical Index below. As you can see, since the stock indexes bottomed out in early March, ^CYC is up a whopping 73%.
Based on their nature - and the fact that defensive stocks haven’t done that well recently, you might conclude that the bear market has ended.
That may be true, but to put things in perspective, ^CYC has tumbled 75% since it topped out in July 2007 - one of the market’s worst performers.
Even if you factor in the recent rally, the index is still 57% below its 2007 high, while the Dow is only 43% off of its high.
This index is worth watching closely over the next few weeks - both from an individual sector standpoint, but also as a broader economic indicator. As the chart shows, there is initial resistance around 527, and then around its November high of 561.
- Bullish Case: If ^CYC can close above the 561 area, it should be bullish over the intermediate-term, as the next major resistance level does not come in until around the 770 area.
- Bearish Case: If ^CYC rallies up to the 510-560 area and then begins to sell off again, the caution flag comes back out.
That wraps up this edition. Talk to you again soon.
Jim Stanton
Editor - 1-2-3 Trader
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