Aluminum, Paper Lead Cyclicals

The paper, metal and chemical stocks that flagged during the second half of last year are coming back - and may be prepping for a big year.

The Morgan Stanley Cyclical Index, comprising stocks of companies that rise and fall with the economy, jumped 8.7 percent in the last two weeks and is back where it was last summer.

Cyclical stocks rose as investors bet that the Federal Reserve would continue trimming interest rates to revive economic growth and fend off recession this year - a wager enforced by the central bank’s rate cut on Jan. 31.

“The market is going to look at the industry groups that will prove to be beneficiaries of an easing of interest rates,” said Peter Keane, a money manager at Sovereign Advisors.

Philip Schettewi at Loomis Sayles & Co., which oversees investments of $2.5 billion, said he is snatching up shares of Inland Steel Industries Inc. among others on a hunch that economic growth will accelerate in the next six to nine months.

“We’re going to try to get ahead by buying some of the stocks before the crowd gets in,” Schettewi said.

These money managers have history on their side.

When the Fed slashed interest rates by 45 percent in 1985 and 1986, it triggered gains first in auto and homebuilding issues and then a rally in metal, chemical and paper shares, according to a report by International Strategy & Investment Group.

After three rate cuts during 1995 and 1996, the “consumer cyclicals haven’t even bounced,” the ISI report said. That means the last fortnight of gains may be the first leg of a rally.

Cyclical companies benefit from economic expansions simply because companies use more paper for packaging, chemicals for plastics and steel for cars when consumers have more to spend. These companies also are among the first to fall when the economy turns down.

Cyclicals grew warts in the beginning of September as concern grew among investors that the slowing economy would stunt their profit growth. Shares of Caterpillar Inc., paper-producer Champion International Corp. and Dow Chemical Co. tumbled as investors fled to consumer-product companies whose earnings usually aren’t affected as much by slowdowns.

But then stellar fourth-quarter earnings from Caterpillar, Chrysler Corp. and International Business Machines Corp. made the group look more attractive again.

As it turned out, companies that make basic materials like steel and aluminum beat analysts’ predictions for their earnings more often than makers of food and drugs did in the fourth quarter, according to Zacks Investment Research.

To be sure, market strategists who predict the economy is heading into tough times are keeping their distance of companies in basic industries.

But most say the Fed will cut rates some more, sparking the economy and demand for basic materials.

“When the market decides it likes cyclicals it does it in a big way,” said Gail Bardin, money manager at Hotchkis & Wiley in Los Angeles, which oversees $6 billion. “The trick is to get in there early.”

And it’s still early, Bardin says. Paper and aluminum stocks are among those that still are overlooked, she says.