It is a fact that cyclical stocks do well when the economy does well. It is also true that stock prices are a reflection of future earnings. The stock market is a forward-looking market. Judging by recent rally driven by cyclical stocks, it may be an indication that the economy is about to rebound.
The Labor Department’s announcement of payrolls going up by 2.5 million in May has been the spark of the recent optimistic outlook. In addition, lockdown orders around the US have been gradually easing. Even though one cannot claim that the economy has recovered, and even though year-over-year comparisons do not look good, the path to recovery seems to be visible.
According to economic strategists at Morgan Stanley, “If certain risks can be avoided, the tailwind for cyclical stock outperformance should continue.” They further added, “Periods of cyclical outperformance are not about any specific level so much as a continued positive rates of change in these variables. Calling inflections helps, but continued positive momentum across these indicators has typically been necessary to sustain outperformance.”
According to the bank, defensive stocks, consumer staples, and utilities stocks had done their job during the worst of the downturn and it was now time to look at cyclical industrials and materials sectors. Automakers, oil majors, and financials are sectors that may be poised to benefit the most from the impending economic recovery. The energy and industrial sectors have both outperformed the S&P500 over the past month. There has also been a rebound in cyclical stock ETF investments.
Some analysts believe that the recent rally in cyclical stocks may be due to sectoral rotation of funds away from defensive sectors and into sectors that are closely linked to the economic cycle. Whether this shift sustains remains to be seen. Perhaps, investors are anticipating a V-shaped recovery.