Cyclical Stocks Relative Strength

I derive the relative strength of the cyclicals via dividing the MS cyclical index ($CYC) by the
$SPX. Chart. The cyclicals have lost relative strength throughout most of 2011 to date as investors
steadily lost confidence in the outlook for US and global economic growth momentum. They have
been following downtrends in various boom / bust indicators and have waived off the very strong
showing in corporate top line growth through the end of Q 3 '11. The interesting thing about the
strength of corporate sales this year has been the recovery of pricing power which has kept top
line momentum brisk even as real volume growth has moderated. The improved pricing power
has led to a significant further improvement in profit margins not only among cyclicals but the
broader corporate universe as well. Investors, wary of indicators which point to slower real
growth momentum, have been unimpressed with better pricing power on the premise that a loss
of real output growth momentum would lead to more timid pricing as companies moved to regain
market share. In fact, the chart suggests that investors were on the verge of throwing in the towel
on the cyclicals until just recently when coincident economic data showed some improvement.

In my view, a sharp break below the .68 relative strength support level seen on the chart would
strongly suggest players had abandoned the idea of meaningful economic expansion for 2012.
One very vexing factor is that the various boom / bust indicators I use to gauge the outlook for
profits accelerated up before the recession actually ended, and did so long before top line
sales growth really took off. This may reflect the fact that the US at least was coming out of
a period of price deflation and that pricing power was quite slow to kick in.

Looking toward 2012, it will be important not just to monitor real growth but inflation as well.
In this latter regard, my inflation pressure gauges have been pointing down, suggesting companies
may find a tougher pricing environment as well. This could affect the outlook for the more basic
or "rotgut" cyclicals.