Cyclical shares have been dramatically underperforming defensive equities during the past year, and especially since the spring of 2012. This is primarily because financial advisors have been repeatedly and foolishly emphasizing "going for yield" and "sticking with the highest-quality companies" and "focusing on well-established brand names". As a result of so many investors crowding into the same defensive high-dividend names, their share prices have mostly doubled since July 2009, while many cyclical shares are still trading close to their lows of July 2009. Thus, as mining and materials and energy and semiconductor companies have become notably undervalued relative to the broader equity market, they are likely to compensate in a big way by surging during the upcoming equity rally. As the S&P 500 is soon climbing about 10% from its current level to retest its 2007 zenith, many cyclical names will soar by 20% or 30%.
There are all kinds of excuses about why cyclical shares have been underperforming, ranging from a slowdown in the Chinese economy to sovereign debt problems in Europe. The above two issues are so well publicized that there can't be a taxi driver in the remotest part of the world who isn't already familiar with them, and therefore anyone who would have sold on this information has long since done so. There do exist real problems with housing bubbles in several dozen countries; as they inevitably burst, this will generate a massive negative wealth effect which could create the next worldwide recession. However, since real estate is a slow-moving illiquid asset, this process generally takes several months or longer to become an important force, and is thus unlikely to exert any meaningful influence on the financial markets for the remainder of 2012 or in the beginning of 2013.
Fund flows demonstrate that investors have been pouring into bond funds and funds of defensive equities, while making net withdrawals from funds of cyclical equities. Top corporate insiders were steadily purchasing the shares of commodity producers near all of their important low points since May 2012, with scattered selling near short-term highs. Since late September, there has been almost no insider buying or selling; during the final weeks of the summer there was significant selling by top executives of many high-dividend consumer companies which had benefited the most from investors crowding irrationally into their shares. TLT and related funds of U.S. Treasuries remain highly popular, but have been forming bearish patterns of several lower highs. Treasuries are likely to continue and to soon accelerate their downtrends which began on July 25, 2012 from all-time historic tops.
The media have turned noticeably more negative toward stocks and commodities in recent weeks. If you count the number of positive and negative analyses on mainstream web sites, the ratio of gloom-and-doom to optimism is quite high. The few articles which recommend buying stocks almost all emphasize the same high-dividend, defensive, "reliable" names which financial advisors have been touting and which are already dangerously overvalued. Almost no one is suggesting semiconductor shares which have gone dramatically out of favor, or the shares of most energy companies, or especially materials producers and mining equities. The best opportunities almost always lie where the vast majority of participants are least likely to be pursuing them.
Disclosure: Since May 2012 I have progressively accumulated substantial long positions in funds of commodity producers near their lows. I currently own GDXJ, VFWPX, KOL, XME, EWZ, SLX, REMX, VINIX, VEMPX, RERGX, RSX, VGPMX, TNRPX, TRIEX, FCG, TAN, GDX, and NLR, in that order, with by far my greatest concentration in GDXJ.
