Stocks paused last week when the Federal Reserve raised interest rates for the 15th time since June 2004. The big question before the expected hike was how investors would interpret the Fed’s language going forward: Would there be another rate hike in May, and would that be the last for a while?
Friday’s most active stocks included: Lucent Technologies (NYSE: LU), Boston Scientific (NYSE: BSX), Time Warner (NYSE: TMX), iShares Japan Index Fund (AMEX: EWJ), Seagate Technology (NYSE: STX), iShare Russell 2000 Index (AMEX: IWM), and Energy Select SPDR (AMEX: XLE).
The answer wasn’t clear, although a good number of analysts believed that the Fed’s release hinted at just that, noting lines such as “inflation remains contained” and the “economy appears likely to moderate to a sustainable pace.”
Combined with other data pointing to slow but steady growth and reduced fears of inflation, investors bought that message, and stocks recovered later in the week. In other words, the good news continued for Fidelity Select Cyclical Industries.
The fund invests in the stocks of companies that stand to benefit from an improving economy, usually a mix of industrials, manufacturing, basic materials and consumer discretionary. It’s a model that’s working, thanks to growth that is “moderate or steady,” according to the Fed’s recent Beige Book.
After a slowdown in the fourth quarter of 2005, when hurricanes shoved gross domestic product growth down to 1.7%, economists are expecting a major rebound, in the range of 4.5% to even 5%. Meanwhile, good news on jobs, consumer optimism, corporate spending and corporate profits in recent weeks seems to bode well for growth, and the fund.
For shareholders of FCYIX, the long, fairly steady ride has only picked up speed in 2006. FCYIX shares gained 4.6% in the month ended March 31 and 12.2% year-to-date, three and seven percentage points better than the S&P 500, respectively.
FCYIX’s climb up the Sector Momentum Table has been no less impressive, from dead last on Jan. 20 to sixth last week, its second straight week in the top 10. In fact, the fund’s roll is much longer than a few months. FCYIX’s returns were stronger than the S&P 500 and Morningstar’s mid-cap value category for one year, three years—where its 31.6% annualized return beat the S&P by nearly 15 percentage points—and five years.
Given the fund’s mandate to follow cyclical stocks, that may be surprising. Since 2000, though, it has outperformed the broader market in good times and in bad, probably because of its strong focus on old-line industries rather than new-economy cyclicals such as telecom and information technology.
The fund’s most recent full holdings report, from Nov. 30, shows big bets on chemical (14.6%), machinery (12.3%) and aerospace and defense (10.8%) stocks, with little or no exposure to IT or telecom, outside of small bites of IT services and communications equipment stocks.
That may also help explain the fund’s standard deviation of 13.05, low for a sector fund. Also, FCYIX holds more stocks—recently 143—than most Fidelity sector funds, with only 29.2% of holdings in the top 10 names.
Those names have done well, and some of the bets made by manager Chris Bartel and his predecessors have led the way, much as industrials have helped the markets this year. Caterpillar, a recent top 10, has diversified its product line while enjoying high demand. Its 25% gain for the first three months of 2006 (and a one-year gain of 60%) placed it near the top of all stocks in the Dow Jones Industrial Average. The DJIA itself, home to several stocks in FCYIX’s portfolio, has been at or near a five-year high in recent weeks.
FCYIX has benefited from growth in emerging markets, because the fund’s stocks cover the firms that produce the commodities and heavy machinery growing countries need. If, as expected, business capital spending strengthens this year, FCYIX could benefit, especially if commodity prices stay high and keep growing but inflation stays under control.
For those betting on continued economic growth, FCYIX certainly looks like a good fit. Still, there are danger signs. Inflation remains a concern, and the stock market could take a hit if interest rates do continue to rise as the summer drags on. There’s also the chance, if rate tightening does stop, that confident investors would turn away from industrials to more risky avenues, such as tech stocks.
Either scenario could signify the end of the good times for FCYIX. FCYIX’s performance over the past five years is impressive. But potential investors should also look a little further back: The fund struggled in the heady days of the late 1990s, trailing the S&P 500 by significant margins in 1998 and 1999.
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Year Total Return (%) +/- vs. Category Avg.*
YTD** +12.1 +5.4
2005 +12.3 +3.9
2004 +23.5 +5.0
2003 +37.6 +1.3
2002 -20.0 -6.7
*Category: Mid-Cap Value
**Through March 31
Top 10 Holdings as of Dec. 31, 2005
• United Technologies
• Tyco International
• Honeywell International
• Emerson Electric
• General Electric
• Lockheed Martin