Up, Down, All Around - Understanding Cyclical Stocks

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Among the basic cyclical industries are steels, machinery, machine tools, oils, chemicals, autos, coppers, nonferrous metals.

Most cyclically oriented industries are generally candidates for substantial improvement in operations beyond the expectation for the economy as a whole. The companies whose stocks are likely to go up the most during the period of recovery are generally the marginal ones, where the earnings improvement stands to be the greatest. These are companies which are capable of generating substantially higher profits in periods of greater demand.

The railroad industry should be among the chief ones to benefit from a turnaround in the business cycle. When the real turn comes in basic heavy industry, there will be the inevitable period of inventory accumulation. Railroad statistics are among the first indicators of improving industrial conditions.

Epitomizing U.S. heavy industry, the steels have long been considered feast-or-famine stocks and depend much upon their most important customer—the automobile industry, which consumes about 20 percent of steel shipments.

It is always difficult to perfectly time the purchase of cyclical stocks. However, risks appear only limited if you know how to buy steel stocks at a low consumer inventory level from which there is not likely much further reduction and which should considerably reduce the industry's downside potential.

Another trick is to coordinate purchase with such events as labor contract negotiations, which will likely stimulate an upswing in demand. Always favored are such leading firms as Bethlehem Steel, Jones & Laughlin and, of course, U.S. Steel, the last being the lowest cost major domestic steel producer. They stand to benefit most from continued technological advances in production and product improvement over the next decade, which may well compare favorably with such strides made during the last 50 years.

While highly cyclical, the automobile industry is believed to possess further growth prospects because of the generally rising basic demand for cars. In his 1960 analysis-forecast of the U.S. economy, economist Arnold H. Johnson stated that it would take 30 million additional cars—some 50 percent more than now in use—to saturate the market. This estimate was based on the fact that 17 million families did not own a car at that time, and that 13 million might go to two cars.

Moreover, according to Johnson, the number of youths reaching driving age has been rising fast. The intermediate-term picture, however, looks far less promising because of the substantially added capacity since 1955. Moreover, the comparatively high profit margins which traditionally justified the relatively high market price of auto shares have dwindled appreciably due to the increased percentage of lower-priced and, therefore, lower-profit margined compacts.

Aluminum issues are also cyclical because of the shifting demand from the building, electrical, automobile, aircraft and missile industries. While at the present time, U.S. capacity for the production of virgin aluminum probably exceeds the demand, many new outlets are in the offing.

The present overcapacity is the result of the enormous postwar build-up of facilities here and in Canada. Few industries have grown since the end of World War II as has the aluminum industry. Since the turn of the century, there has been a doubling of output every decade.

Further growth prospects for this light metal, however, are excellent because of its greatly broadened market. The volume of aluminum going into new houses has been increasing. The container field offers considerable promise for aluminum. In the automobile industry, aluminum stands to benefit from the trend toward compact cars.

With the expected continued growth of aluminum use at about 8 percent a year, present overcapacity may well be temporary.

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