Hitting the peak?

20 March 2008

Having lagged behind mainstream markers like the Dow and S&P 500 for the last few months, the ACT's share index for American heavy equipment manufacturers saw steep growth in April and May to bring it back on par.

This was no mean feat. Both the Dow and S&P 500 hit record levels at the end of May, and it took a new high of 177.1 points for the ACT HEI to get back up there. As our graph shows, the performance of all four Indexes over the last 12 months look pretty similar, with net gains over the period ranging from 17.7% for the Dow to 21.7% for the ACT HEI.

While these are in an unusually close band, the paths the various indexes have taken over the last year have been significantly different. The Dow, NASDAQ and S&P 500 have had a slow and steady climb, with only a few bumps along the way. In contrast, the ACT HEI with its cyclical stocks has fallen much further during the sell-offs and climbed much more steeply in the buying periods.

Another point to make is that equities have performed extremely well over the last year. Despite the downward corrections of this February and last May, even the laggard index - the Dow - is up 17.7% over the last 12 months. That's obviously a long way ahead of other common investment instruments such as bonds or savings, where a 5% to 6% return would be the order of the day.

But in some senses, this is also the key weakness of the equity markets. Such strong returns tend to lead to volatility, with investors looking to sell-off at the peak for maximum profits. Once a sell-of begins and share prices begin to fall there is often a sharp decline, because everyone piles in before prices fall even further.

With such sharp improvements in share prices, both in the heavy equipment sector and the mainstream markets in general, the likelihood is rising that there will be this kind of sharp downward correction.

Any number of things could trigger a sell-off, but one of the areas that stocks are most sensitive to this year is interest rates. The economy has been more robust this year than some had forecast, but the flip side to this is that inflation is becoming more of a concern. This could see rates pushed up again, which would undoubtedly trigger a fall.


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