Stocks Show Economy Revving as Cyclical Shares Win

March 22 (Bloomberg) -- Retailers erased their stock market losses since the collapse of Lehman Brothers Holdings Inc. and transportation companies doubled in a year, signs the advance in U.S. equities is just getting started.

Amazon.com Inc. and Gap Inc. have wiped out declines of as much as 63 percent since the bear market began in October 2007 amid forecasts retailers’ profits will increase 63 percent through 2012. The Dow Jones Transportation Average, where earnings are projected to almost triple in two years, is beating the Standard & Poor’s 500 Index by 32 percentage points since March 2009, the widest gap for a rally since 1990.

Investors seeking signals equities will keep rising are finding them in industries most tied to the economy, the basis for a century-old forecasting technique known as Dow Theory. While bears say the gains aren’t justified by earnings and that shares are climbing too fast, Stephen Lieber of Alpine Woods Capital Investors LLC and David Darst of Morgan Stanley are buying on speculation the expansion will revive profit growth.

“This is not a junk stock rally,” said Lieber, who helps manage more than $7 billion in Purchase, New York. “This is a restoration-of-confidence rally. This is a business confidence rally.”

Lieber owns Intel Corp., the Santa Clara, California-based semiconductor maker that climbed to an 18-month high of $22.24 last week amid optimism sales to business customers are growing.

Winning Streak

The S&P 500 increased 0.9 percent and the MSCI World Index of stocks in 23 developed nations climbed 0.3 percent as both measures advanced for a third week. Government reports showing higher consumer spending and lower-than-expected inflation have pushed the Dow Jones Industrial Average up 3 percent in 2010, according to data compiled by Bloomberg. The S&P 500 slipped 0.1 percent to 1,158.79 at 9:55 a.m. in New York today.

An exchange-traded fund that matches the performance of the U.S. benchmark index, the SPDR S&P 500 ETF Trust, rose 14 straight days through March 17, the longest streak in its 17- year history. The 11-day winning streak by the Dow transports that ended last week was the best since 1992, data compiled by Bloomberg show.

Companies whose profits are most tied to changes in U.S. gross domestic product are beating those with the smallest connection to the economy by the widest margin on record.

The Morgan Stanley Cyclical Index, a measure of 30 stocks from Dearborn, Michigan-based Ford Motor Co. to U.S. Steel Corp. in Pittsburgh, has surged 209 percent since March 6, 2009. It topped the Morgan Stanley Consumer Index, a gauge of companies such as Pfizer Inc. and ConAgra Foods Inc. that do relatively well during a contraction, by 147 percentage points.

Twice the Gain

The cyclical index has also provided almost double the return since Feb. 8, when the S&P 500 began rebounding from a three-week drop that erased 8.1 percent, according to data compiled by Bloomberg.

Manufacturing and industrial stocks in the S&P 500 are up 11 percent in 2010, beating nine other groups in the index by at least 2 percentage points, data compiled by Bloomberg show. This is the first time since 1985 that the measure, which includes Chicago-based Boeing Co., the world’s second-largest commercial plane-maker, and General Electric Co. in Fairfield, Connecticut, the biggest supplier of power turbines, has led this far into a year, according to Birinyi Associates Inc., the Westport, Connecticut-based research firm founded by Laszlo Birinyi.

“We are still bullish on risk assets,” said Darst, the New York-based chief investment strategist at Morgan Stanley Smith Barney, which oversees $1.6 trillion. “We see a multiyear cyclical bull market.”

High Velocity

The speed of the rebound in stocks since Feb. 8 is reason to doubt its sustainability, says Andrew Lapthorne, global head of quantitative strategy at Paris-based Societe Generale. The relative strength index using 14 days of data for the SPDR S&P 500 ETF rose to 76.76 on March 17, the highest level since October 2006. Surges in the RSI mean a security may have climbed too far, too fast.

Rallying stocks have pushed the S&P 500’s price relative to earnings in the last 12 months to 18.6 times. The average multiple over the last 56 years is 16.6, according to data compiled by Bloomberg.

“The long-term valuation expectations are way, way too high,” said Lapthorne. “I don’t think there is much value in the markets. It has the potential to drive violently downwards.”

Amazon, Old Navy

Investors should bet that companies with the best earnings prospects will outperform, Robert Buckland, an equity strategist at Citigroup Inc. in London, wrote in a March 17 report. Stocks that fell the most in the 2007 to 2009 bear market helped propel the S&P 500 during the past 12 months and cyclical stocks will help lead the market in the next two years, Buckland said.

Amazon, the Seattle-based owner of the world’s biggest Internet retailer, has doubled since the stock market bottomed in 2009 and gained 12 percent over the last six weeks. San Francisco-based Gap, which runs namesake clothing stores and Old Navy, is up 22 percent in the past six weeks.

Both stocks helped send the S&P 500 Consumer Discretionary Index, a measure of companies reliant on Americans’ spending, past its level on Sept. 12, 2008, just before Lehman’s bankruptcy froze credit markets and $1.7 trillion in bank losses spurred the worst recession in seven decades.

Buffett’s Indicator

The average analyst estimate for Amazon’s 2011 earnings has increased 14 percent to $4.78 a share this year. Gap’s has risen 4.8 percent to $1.73. Profit for companies in the consumer discretionary index are forecast to surge an average of 57 percent to $21.66 a share through the end of 2012, according to data compiled by Bloomberg.

Warren Buffett said on Nov. 3 that he made an “all-in wager” on the strength of the U.S. economy when he bought Fort Worth, Texas-based railroad Burlington Northern Santa Fe Corp. for $27 billion, the biggest purchase of his career.

Buffett, 79, the billionaire chairman of Berkshire Hathaway Inc. in Omaha, Nebraska, told ABC News last year that U.S. rail- freight traffic is among the most important measures of economic health. Trains hauled 287,837 carloads for the week ended March 13, near the highest level in a year, data from the Washington- based Association of American Railroads show.

‘Coming Back’

The rebound in shipping has helped push the Dow Jones Transportation Average up 104 percent since the market low, compared with the S&P 500’s 71 percent jump. Companies in the gauge are projected to report a 173 percent increase in profits in the next two years, led by a sixfold gain at Honolulu-based Alexander & Baldwin Inc., which operates barges, data on operating profits compiled by Bloomberg show. By comparison, earnings among S&P 500 companies may grow 52 percent during that time, the data show.

“The cyclical stocks are coming back because the economy is coming back,” said Jeffrey Saut, the chief investment strategist at Raymond James & Associates, which manages $230 billion in St. Petersburg, Florida. “I’m still bullish into the summer.”

Dow Theory, developed by Wall Street Journal co-founder Charles Dow in the 1800s, suggests the rally in U.S. equities may continue. Dow’s transportation and industrial averages both reached the highest levels since October 2008 last week.

Stocks that fell the most during the bear market plunge have been the biggest winners in the rebound, according to data compiled by Bloomberg. Financial shares in the S&P 500 have risen 152 percent in the past year. Investors from Paulson & Co. to Fairholme Capital Management are loading up on the group. Regulatory filings show banks, brokerages and insurers make up 19 percent of hedge fund equity holdings, the biggest allocation compared with other industries.

“I’m bullish,” said John Carey, a Boston-based money manager at Pioneer Investment Management, which oversees more than $220 billion. “The economy is improving, corporate earnings look good and there’s still great value in the market.”