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Fearing Sticky Inflation? Play Cyclical Sector ETFs
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While we have been grappling with high inflation for more than a year, we should note that the U.S. inflation has already peaked and has been on a downtrend now. Year-over-year CPI peaked at 9.1% in June last year, and since then monthly readings have steadily declined.
The most recent CPI report, for April 2023, showed prices up 4.9% over the prior 12 months, the lowest since April 2021, and below market forecasts of 5%. While rising inflation data spark rising rate concerns and a falling stock market, history suggests that inflation has not been a problem for equities.
Goldman analysts said last year that history indicates the market reacts positively when inflation shows signs of peaking, as quoted on a CNBC article. “The market usually falls in the run up to the peak in headline inflation. But after the peaks, there is a little more variance and on average the market does recover,” the CNBC article went on to highlight a year ago.
In the previous 13 inflation rally since 1951, the market was higher 12 months later nine times. The biggest gain was a 33.2% increase from the March 1980 top, per that article. Even if there are steady rate hikes, we see no need to fear rising rate risks. The last full cycle of rate increases happened in the United States between June 2004 and June 2006 as rates progressively rose from 1.00% to 5.25%.
Cyclical Sectors to Sizzle?
Historically, cyclical sectors outperform the defensive ones when rates normalize. In a growing market, most sectors surge from a wealth effect, with a few of the more cyclical corners making the most of the rally. These industries often sag in a slumping economy but are the biggest winners during a revival.
The signing of the U.S. debt deal should also bolster cyclical sectors as these were so far kept under the shadow of the tech rally. Notably, sectors enjoying positive earnings growth in Q1 of 2023 include Transportation (+56.9%), Consumer Discretionary (+31.2%), Aerospace (+15.7%), Energy (+15.5%), Finance (+1.4%), Retail (+3.1%), Autos (+10.4%), Business Services (+2.1%), and Industrial Products (+17.0%), per Earnings Trends issued on May 31, 2023.
The sector is likely to benefit from the rising income levels of consumers. Despite high inflation, consumer spending remains strong. The ebbing pandemic and the pent-up demand have been aiding the demand of the space.
The ebbing pandemic is a plus points for the transportation sector. The industry has been enjoying continued strong demand with improvements in the supply chain. Delays still exist, but supply chain issues are slowly improving. This can be viewed as a ray of hope.
Though the U.S. market has seen the regional banking crisis in March, the crisis is now more-or-less contained. The steepening of the yield curve is a plus for the bank space. Also, banking stocks offer value now. Banking stocks are highly cyclical as these are vulnerable to changes in economic conditions and policies.
Auto – First Trust S-Network Future Vehicles & Technology ETF (CARZ - Free Report)
The sector is expected to fare better in Q1 earnings. Decent sales of Motor Vehicle & Parts and the price inflation of new cars have been palpable. Both factors indicate that the business conditions remained favorable for the auto industry.
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Fearing Sticky Inflation? Play Cyclical Sector ETFs
While we have been grappling with high inflation for more than a year, we should note that the U.S. inflation has already peaked and has been on a downtrend now. Year-over-year CPI peaked at 9.1% in June last year, and since then monthly readings have steadily declined.
The most recent CPI report, for April 2023, showed prices up 4.9% over the prior 12 months, the lowest since April 2021, and below market forecasts of 5%. While rising inflation data spark rising rate concerns and a falling stock market, history suggests that inflation has not been a problem for equities.
Goldman analysts said last year that history indicates the market reacts positively when inflation shows signs of peaking, as quoted on a CNBC article. “The market usually falls in the run up to the peak in headline inflation. But after the peaks, there is a little more variance and on average the market does recover,” the CNBC article went on to highlight a year ago.
In the previous 13 inflation rally since 1951, the market was higher 12 months later nine times. The biggest gain was a 33.2% increase from the March 1980 top, per that article. Even if there are steady rate hikes, we see no need to fear rising rate risks. The last full cycle of rate increases happened in the United States between June 2004 and June 2006 as rates progressively rose from 1.00% to 5.25%.
Cyclical Sectors to Sizzle?
Historically, cyclical sectors outperform the defensive ones when rates normalize. In a growing market, most sectors surge from a wealth effect, with a few of the more cyclical corners making the most of the rally. These industries often sag in a slumping economy but are the biggest winners during a revival.
The signing of the U.S. debt deal should also bolster cyclical sectors as these were so far kept under the shadow of the tech rally. Notably, sectors enjoying positive earnings growth in Q1 of 2023 include Transportation (+56.9%), Consumer Discretionary (+31.2%), Aerospace (+15.7%), Energy (+15.5%), Finance (+1.4%), Retail (+3.1%), Autos (+10.4%), Business Services (+2.1%), and Industrial Products (+17.0%), per Earnings Trends issued on May 31, 2023.
Consumer Discretionary – Consumer Discretionary Select Sector SPDR Fund (XLY - Free Report)
The sector is likely to benefit from the rising income levels of consumers. Despite high inflation, consumer spending remains strong. The ebbing pandemic and the pent-up demand have been aiding the demand of the space.
Transportation – SPDR S&P Transportation ETF (XTN - Free Report)
The ebbing pandemic is a plus points for the transportation sector. The industry has been enjoying continued strong demand with improvements in the supply chain. Delays still exist, but supply chain issues are slowly improving. This can be viewed as a ray of hope.
Financials – SPDR S&P Bank ETF (KBE - Free Report)
Though the U.S. market has seen the regional banking crisis in March, the crisis is now more-or-less contained. The steepening of the yield curve is a plus for the bank space. Also, banking stocks offer value now. Banking stocks are highly cyclical as these are vulnerable to changes in economic conditions and policies.
Auto – First Trust S-Network Future Vehicles & Technology ETF (CARZ - Free Report)
The sector is expected to fare better in Q1 earnings. Decent sales of Motor Vehicle & Parts and the price inflation of new cars have been palpable. Both factors indicate that the business conditions remained favorable for the auto industry.