As the Economy Starts to Normalize, the Market Looks to Cyclicals

The housing situation, meanwhile, has changed in the last month. U.S. mortgage applications fell for the fourth consecutive week, a sign not of slowing demand, but of reduced supply. At the same time, the median price of a new home in February was $349,000, up 5.3% from a year before — and the mean price of a new home is up 7.7% — an affordability issue that investors should keep an eye on, as it could potentially affect demand in related industries. 

That said, housing remains strong on an absolute basis, given that demographic trends point to more millennials buying homes. When considering investing in companies affected by housing — such as large hardware chains, paint companies and other home improvement plays — remember that housing represents 15-18% of GDP. Like manufacturing, homeownership also has a multiplier effect. After purchasing a home, consumers need to buy items to fill it, which boosts spending. 

Structuring Portfolios: Overweight Cyclicals

Higher growth, combined with modest inflation, suggests increased opportunity this year in economically sensitive cyclical stocks. My portfolio is currently 70:30, cyclicals to growth. Consider manufacturing  — including semiconductor manufacturing — mining and chemicals, as well as consumer, auto, and companies that benefit from the increase in home buying.  I watch for companies with operating leverage, and strong top-line revenue growth and margins. 

I continue to look closely at the consumer savings rate, which stands at 19.8% compared with the historical norm of 5%. This high savings rate represents an enormous amount of pent-up demand. As the economy opens up and consumers resume shopping, traveling, eating out and other entertainment, we can expect a significant amount of new spending, which will fuel growth in the stock prices of companies on the receiving end of renewed consumer optimism.

While I don’t believe in pitting value against growth, I see more opportunity in value in the coming months. Energy is the leader — with the S&P 500 Energy Sector Index up 29% since Jan. 1 — but the financial sector index is also up 17% and the materials index is up 10%. These are key areas to watch as the economy starts to accelerate.

With GDP expected to recover significantly in 2021 — in my estimation, perhaps reaching 8-10% growth — earnings stand to benefit. We could see S&P earnings growth for this year versus 2020 levels, possibly north of 30%. 

While my equity portfolio is about 70% cyclicals, including value stocks, I have 30% in growing technology companies — for example, 5G companies, cloud computing, artificial intelligence and wearables. I firmly believe that the total addressable markets in these areas are significant and cannot be overlooked in a diversified portfolio.

The first quarter of 2021 certainly looked different than Q4 2020. Yields have climbed back to pre-pandemic levels, the stimulus checks are getting cashed and spent, and leading indicators for increased economic activity — such as copper prices — continue their march upward. Combined with improving U.S. economic data, it’s clear to market participants that the stimulus and vaccines are working. 

We can expect to see hotter inflation numbers in the coming weeks and months, which may spook some market participants. However, those of us who remember the economy pre-2008 know that a “normal” healthy economy is characterized by a bit of inflation, better growth and higher interest rates. With that in mind, investors in cyclicals and value stocks should watch the recovery’s progress closely. Don’t follow the herd, and think carefully about when to trim allocations and rotate holdings.

Stephanie Link is chief investment strategist and portfolio manager at the national wealth management firm Hightower. She leads the firm’s Investment Solutions Group, which specializes in outsourced chief investment officer services, model portfolios, separately managed accounts, investment research and due diligence for Hightower advisors. Follow Stephanie on LinkedIn and Twitter @Stephanie_Link

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