A Merrill Lynch index for all seasons :: Part 1 of 4

Merrill Lynch created a series of four benchmark indexes designed to cover companies affected by different parts of the economic cycle. These indices are good source of investment ideas for large cap stocks. Over the next few days I’ll discuss each index and my thoughts on the investment outlook for that index.

Merrill Lynch Early Cyclical Index consists of stocks that Merrill Lynch believes would benefit during the early part of the economic cycle in which there is increased consumer spending. The index components include automobile, building materials, household equipment, retail and homebuilding stocks in the S&P 500.

Sharing the fate of companies in this sector are retail REIT's, such as Simon Property Group (SPG) or Pan Pacific Retail Properties (PNP), that operate shopping malls. Of the index companies, I think that Target Corp (TGT) and Costco wholesale corp (COST) are the most interesting. TGT and COST have best consumer perception in their respective sectors of big box discount retail and warehouse stores. Both companies compete with Wal*Mart and both Costco and Target have been taking share from the market leader.

This index has been quite stagnant since November of 2005, which is in harmony with reduced spending on consumer "capital goods" such as cars and houses. Rising interest rates and the loss of high paying jobs from the US suggest this trend of reduced spending on cars, homes and gadgets will continue. The debt capacity of many consumers has been drawn down. Many consumers can no longer tap home equity and personal credit lines to pay for spending. As the Fed Funds rate (as well as the prime interest rate) rises, many consumers are forced to devote increasing amounts of personal income to debt service.

Part two of this series covers the Merrill Lynch Interest Rate Sensitive Index