As the bull market gets a new lease on life, Wall Street is growing less fretful of a U.S. growth slowdown and betting on shares of companies in sectors that will benefit from the economic up-cycle, such as industrials and financials.
After tumbling nearly 20% from its peak at the end of 2018, the S&P 500 (.SPX) has rebounded strongly this year as U.S. economic data remain robust and the Federal Reserve has indicated a pause in interest-rate hikes. Last week’s U.S. gross domestic product reading, which put first-quarter growth at a 3.2% annualized rate, further bolstered economic sentiment.
Accordingly, fears of a stock market meltdown have given way to talk of a possible melt-up. The S&P 500 has notched record highs in the past three trading sessions.
As a result, shares of companies in cyclical sectors and industries - those whose fortunes ebb and flow in tandem with the economy - have grown more attractive. Indeed, industrials and consumer discretionary stocks have outperformed the S&P 500 this year.
Industrials are well placed to continue their ascent, especially if the United States and China reach a trade agreement as anticipated, said Tim Ghriskey, chief investment strategist at Inverness Counsel in New York. Last year’s trade tensions greatly contributed to the economic worries at the end of last year, he said.
“Part of the reason for the slowdown has been trade,” he said. “You’re likely to see a rebound in demand for products from industrial companies as you see a pickup in the economy.”
Adrian Helfert, director of multi-asset portfolios at Westwood Holdings Group in Dallas, has grown bullish on homebuilders, which are positioned within the consumer discretionary sector. The industry is likely to benefit from low unemployment and low inflation, he said.
Indeed, as mortgage rates have eased from their levels late last year, shares of housing-related companies have risen. The PHLX Housing Index (.HGX) has climbed 29.3% this year, ahead of the S&P 500.
Another cyclical sector, financials, has not had the same resurgence as industrials this year, but some investors believe that economic conditions could soon boost those shares as well.
In March, a brief inversion of the yield curve between three-month Treasury bills and 10-year notes, considered a sign of an impending recession, alarmed investors. The curve has steepened since then and yields have ticked up as U.S. economic data have remained largely upbeat.
The recent uptick in Treasury yields suggests that the global economy is still expanding, which would help shares of U.S. banks, said Helfert of Westwood Holdings Group.
“U.S. banks have corrected much faster in terms of balance sheet size than European banks, and yields will likely continue to climb on the prospect of higher growth,” he said.
If the yield curve were to steepen further, it would particularly benefit shares of small-cap banks, given their reliance on lending as a source of revenue, said Robert Phipps, director at Per Stirling Capital Management in Austin, Texas.
“Until recently, they couldn’t make money doing that,” he said. “Some weight has been taken off the sector with the steepening yield curve.”
More room to run
As investors bet on strong returns in cyclical sectors, they are also confident that U.S. stocks at large will continue their run.
That run could be extended, some believe, as investors who remain on the sidelines put more money into stocks. Despite this year’s gains, investors have largely poured money into bond funds at the expense of equity funds.
U.S.-based equity mutual funds posted $3.64 billion of cash withdrawals in the week ended April 24, extending their weekly outflows since mid-February, according to Lipper. Conversely, bond funds, which include taxable and municipal debt funds, brought in a net $8.8 billion last week to continue a streak of positive inflows over every full week of the year to date.
That trend could soon reverse as the strengthening economy increases investors’ appetite for riskier assets, BlackRock chief executive Larry Fink told Reuters in a recent interview.
“I think we have the economic tailwinds to say we’re going to probably break through,” said Bucky Hellwig, senior vice president at BB&T Wealth Management in Birmingham, Alabama. “To the extent the economy does grow at a higher rate the rest of the year, that’s going to broaden the rally out.”
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