Is Now The Time To Get Bullish On Cyclical Stocks?
Investing.com | Nov 21, 2019 10:01
After much talk of an imminent recession, we find ourselves once again back in a roaring bull market. The latest leg higher in equities — which has pushed the benchmark indices to records — is making some beaten-down stocks attractive again and prompting investors to buy cyclical stocks, which are closely tied to the performance of the economy.
But despite this euphoria, triggered by some improvements in trade negotiations between the U.S. and China, it’s not yet clear how sustained that turnaround will be and whether we can comfortably call a bottom in cyclical stocks, such as industrials.
In an economy where the unemployment rate remains at a historically low level and the central bank is ready to cut interest rates, there are still some signs of trouble on the horizon.
The U.S. Commerce Department, for example, reported last Friday that retail sales in October failed to rebound, following a weak reading in September. That prompted JPMorgan Chase & Co. to cut its fourth-quarter estimate of gross domestic product to 1.25% from 1.75% on an annualized basis.
On the U.S.-China trade front, the news flow is certainly positive and it’s possible that both countries might soon conclude the first phase of their trade deal. But, in our view, it’s still risky to build too much excitement around these talks. Both countries continue to send conflicting signals and there is very little information available to conclude that all is going well.
While negotiators held “constructive discussions” over the weekend, CNBC reported on Monday that China is pessimistic about reaching a deal due to U.S. President Donald Trump’s reluctance to roll back existing tariffs.
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Despite these concerns, the stock market’s current rally shows that investors this time are almost certain there will be a positive outcome which will fuel growth and pave the way for companies to meet earnings estimates for 2020.
When the trade war escalated early this year, investors shunned cyclical companies. But that trend is changing fast with many such sectors outperforming the S&P 500 for now. The KBW Nasdaq Bank index, for example, has posted a 26% gain year-to-date, compared with the S&P 500’s 24% rise. The S&P 500 industrials sector is also outperforming the broader market, up 28% so far this year.
If you’re skeptical about this one-sided market view, then it’s a prudent strategy to not get too excited and buy stocks which will quickly give up their gains at the first sign of trouble.
Shares of 3M Company (NYSE:MMM), one of the world's largest industrial conglomerates, is an example of a stock we recommend avoiding while the recovery remains on shaky ground. Since early October, the stock has recovered 13%. However, it fell 1.7% yesterday, to close at $167.77.
The Minnesota-based maker of things from Post-its to air filters and touch screens lowered its earnings and revenue forecast for 2019 last month, with Chief Executive Officer Michael Roman citing a “challenging” macroeconomic environment. That weakness was broad-based, suggesting demand for its industrial products is getting hit from all directions.
The shares of powerful mining and construction equipment maker, Caterpillar Inc (NYSE:CAT) also staged a strong rebound since early October, surging more than 20%. The stock has slipped in the last three sessions, dropping 1.2% yesterday, to end the day at $141.52.
UBS, in a recent note, downgraded Caterpillar stock, saying more than half of the company’s end markets will “peak” in 2019, “pressuring revenue and margins in 2020 as demand declines.”
The weak prospects from Caterpillar, considered an economic bellwether, are in line with the latest global economic forecasts from the IMF and OECD. Both institutions have cut their projections for major economies in 2019 amid geopolitical and trade tensions.
Bottom Line
The recent show of strength by U.S. markets is mainly fueled by interest rate expectations and hopes that the trade dispute with China will be resolved. Despite these positive developments, it’s not an “all-clear” scenario and many risks are still lurking. In this uncertain situation, it’s better not to buy stocks which have proved too risky and volatile, such as 3M and Caterpillar.
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