Filmed by Nicola Stansfield. Produced by Filip Fortuna.
Cyclical companies typically see their fortunes ebb and flow with the economy. Often, they sell stuff that their customers only buy when they feel positive about their finances and the world around them. As a result, the movement is cyclical stocks can signal something about the economy's prospects.
Automobile manufacturers are a typical cyclical group. They make an expensive discretionary item which most households think very carefully about before buying. Clearly, portfolio managers feel the same way these days. Global auto stocks have performed pretty badly for the past two years, trailing broader market by about a fifth. There are some notable winners buried in that average, though.
Tesla, in which China's Tencent took a 5% stake this week, has done pretty well for investors. On the other hand, Korean automakers, Hyundai and Kia stand out as losers. GM has actually performed reasonably well versus its global peers despite the protestations of activists fund manager David Einhorn. Concerned about GM's lacklustre performance, he has suggested that its shares might receive a higher valuation if split into income and growth securities.
And that raises another point. Relative valuations of those stocks are historically cheap. Priced to cash flow multiples, compared with world markets, have fallen to 15-year lows. Traders likely have doubts about the earnings growth for automakers. And Peter Lynch, the former fidelity star fund manager, he never met a cyclical he liked. He believed that very low valuation alongside record profits that have grown for many years means the market anticipates some sort of downturn.
And that is what has happened in the car sector. Global auto earnings have recently crested at historical highs. Part of the valuation issue might involve concerns about the potential hit from driverless and electric cars. But note that after a surge in the second half of last year, all US cyclicals have faltered this year, especially against defensive sectors such as telecoms and utilities.
Since 2004, when cyclicals start to trail defensives, the S&P 500 usually peaks within a month, notes Credit Suisse. Auto stocks are providing an early steer about the sentiment toward future economic growth. Watch for the turn.