Cyclical sector rally banks on global economic expansion
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[October 13, 2017]
By Lewis Krauskopf
NEW YORK (Reuters) - U.S. stock sectors
that are particularly dependent on economic growth recently grabbed hold
of the market’s rally and are poised to keep the reins should further
signs of global expansion emerge.
Such sectors, including energy, industrials and financials, beat the S&P
500’s 1.9 percent gain in September. Those sectors had previously lagged
behind the benchmark S&P <.SPX>, which has climbed 14 percent this year
while feasting on a steady diet of record highs. Instead, shares of
technology and healthcare companies, whose profits are more impervious
to economic down cycles, have led 2017’s rally.
The question for equity investors is now: Was September just a catch-up
period for the lagging, cyclical sectors, or can an economic lift
support a sustained run?
“If it’s just a mean-reversion trade, then it’s probably going to last
another few weeks and then we’re back to the old winners,” said Walter
Todd, chief investment officer at Greenwood Capital Associates in
Greenwood, South Carolina. “If it’s something more fundamental, it
should be longer lasting than that.”
A test comes next week, as third-quarter corporate earnings season kicks
into high gear. Reports from industrial conglomerates General Electric <GE.N>
and Honeywell International <HON.N>, railroads CSX Corp <CSX.O> and
Kansas City Southern <KSU.N> and steel company Nucor Corp <NUE.N> stand
to yield insight into the economy's health.
September's stock action, which also included outsized gains for
small-cap stocks, had echoes of the immediate aftermath of President
Donald Trump's election in November 2016.
The same areas showed strength on hopes that a Republican-led federal
government would push through an agenda, including tax cuts and
deregulation, that juices economic growth. Those trades faded as Trump
struggled to rack up any significant legislative wins.
Now, investors say, September's stock rally for those groups again
stemmed at least in part from policy hopes, as Trump revved up his
tax-reform push.
“In many ways, we began to replicate the market performance following
Trump’s election,” said Quincy Krosby, chief market strategist at
Prudential Financial in Newark, New Jersey.
But an improving economic picture in the United States and globally
lends confidence for the cyclical sector rally.
The Citi economic surprise index for the United States <.CESIUSD>, a
measure of economic data that can come in weaker or stronger than
forecast, is around a five-month high, with the barometer trending
higher since hitting multi-year lows this summer.
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Traders work on the floor of the New York Stock Exchange (NYSE) in
New York, U.S., October 4, 2017. REUTERS/Brendan McDermid
This week, the International Monetary Fund upgraded its global economic
growth forecast for 2017 by 0.1 percentage point to 3.6 percent, and to
3.7 percent for 2018, from its April and July outlook, driven by a
pickup in trade, investment, and consumer confidence.
The U.S. Commerce Department last month revised its estimate for
second-quarter gross domestic product growth to 3.1 percent, up from 3
percent.
“We've just had better data," said Jim Paulsen, chief investment
strategist at The Leuthold Group in Minneapolis, who also points to
indicators such as firming industrial commodity and oil prices and a
rise in the Baltic Exchange's main sea freight index <.BADI>.
“Those things are all kind of reflecting a realism of economic momentum,
not just a one-off, Trump pie-in-the-sky expectation about policy
change,” Paulsen said.
Bets seemed to build on the cyclical sectors in the first week of
October, which saw flows into the largest sector exchange-traded funds
for financials, industrials and energy, and outflows for
technology and healthcare, according to Lipper data.
“There is some momentum developing in these underperforming sectors,"
said Anthony Saglimbene, global market strategist at Ameriprise in Troy,
Michigan.
Earnings results could sway that momentum. Technology, which has gained
29 percent this year, topping all sectors, is expected to post a 12.2
percent increase in third-quarter profits, more than twice the expected
rise for cyclical groups such as industrials and materials.
Kate Warne, investment strategist at Edward Jones in St. Louis, said
global growth "hasn’t been strong enough for investors to feel
comfortable that we will continue to see the earnings delivered by those
companies in the way that tech and healthcare have consistently
delivered stronger earnings.”
"For the cyclicals to continue to outperform, we have got to see signs
that economic growth globally is accelerating, even compared to what we
have seen so far this year," Warne said.
(Reporting by Lewis Krauskopf; Editing by Jennifer Ablan and James
Dalgleish)
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