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Cyclical stocks will make you money in 2007, say strategists

by Wayne Cheveldayoff, 2006-11-23

Even with the worry of a weakening housing sector and its potential to slow the U.S. economy further, some market strategists are optimistic that investors can make money in stocks in 2007.

“Election cycle says buy the cyclicals,” according to George Vasic, Toronto-based equity strategist at UBS Securities Canada.

“Year three of the U.S. presidential election cycle has been the best year for both the S&P/TSX Composite and the S&P 500 and neither have declined in it during the last half century,” he says. Year three in the current episode is 2007.

The 50-year record shows cyclical stocks (metals, industrials and oil and gas) have consistently outperformed other sectors in year three and “in view of our analysts’ positive view in the resource sector, and the recent downgrade of several bank ratings (by analysts) due to recent price gains, we think (the cyclical) sector looks like a good Plan A for 2007,” he states.

UBS’ research shows that since 1956, the largest gain for the S&P 500 in year three was 34.1 per cent in 1993 and the smallest was 2 per cent 1985, with the average 19.1 per cent.

In Canada, the S&P/TSX Composite recorded its largest year-three gain of 38.4 per cent in 1977 and its smallest of 1.3 per cent in 1957, with the average 15.8 per cent.

Breaking it down by sector, the metals and minerals sector of the Toronto Stock Exchange gained 24.3 per cent on average in year three. Other sectors beating the index were industrial products, up 23.1 per cent, oil and gas, up 22.2 per cent, and communication and media, up 16.2 per cent.

Underperforming sectors also showed gains on average, including consumer products (15.2 per cent), merchandising (13.1 per cent), utilities (12.3 per cent), gold and precious metals (10.7 per cent), paper and forest products and pipelines (9.6 per cent). Financial services, which have enjoyed a run-up in recent weeks, came in last with an average year-three gain of 9.3 per cent.

For 2007, this historical picture “accords with our bottom-up views, which are positive on the resources (including the golds for 2007 since we look for the U.S. dollar to decline, though not paper and forest due to the higher Canadian dollar that would also emerge) and have become more neutral for the large-weighted financials after recent strong gains.

“Finally, this sector pattern fits with that seen after the Federal Reserve stopped hiking rates in 1995, which also was a mid-cycle slowdown and year three of that election cycle.”

The Federal Reserve stopped hiking its Fed Funds rate this summer, leaving it at 5.25 per cent this fall.

The positive outlook for energy stocks, at least for the beginning of 2007, is shared by Don Vialoux, who combines technical, seasonal and fundamental analysis in his daily investor letter (see www.timingthemarket.ca).

“The best period of seasonal strength for crude oil is from the end of November to the end of March. Crude oil has gained in five of the past five periods and the average gain per period was 17.4 per cent,” says Vialoux.

For the coming months he sees supportive indications from his technical analysis of oil-price movements as well as, on the fundamental side, the production reductions by OPEC, the expected pickup in demand this winter, rising demand from Asian nations such as China and India, and the likelihood that geopolitical events also will continue to influence prices.

These positive predictions for cyclicals may be surprising to investors who have watched the resource sector lag recently while technology and financial stocks have enjoyed upswings.

However, sector rotations do frequently occur in stock markets and when it is well-established that the U.S. economy is only in a temporary slowdown, it is reasonable to expect a resumption in strength for those sectors dependent on a positive turn in the economic cycle. The spoiler to this scenario would be a full-blown U.S. recession.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.



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©2006 Wayne Cheveldayoff