After some positive developments on the trade war front, and three interest rate cuts by the Federal Reserve this year, Goldman Sachs says now’s the time to consider cyclical stocks.
“Our economists believe that tariffs have peaked and that the drag on US GDP attributable to the US-China trade war is now abating,” said David Kostin, Goldman’s chief U.S. equity strategist, in a note. “Their base case is that tariff levels on imports from China remain flat in 2020.”
As conditions have improved and recession fears have faded, cyclicals have been outperforming their defensive peers over the last three months. While the S&P 500 gained around 8% during the period, cyclical stocks have delivered a return of about 12%, and the bank says this trend will continue.
“The equity market is anticipating an acceleration in US economic growth during the coming months,” Kostin wrote. “Investors who want to capture further cyclical upside can improve risk-reward by narrowing their focus to select cyclical stocks.”
The firm screened the stocks in the Russell 1000 index for those that have high economic sensitivity but still-depressed valuations, narrowing the names down to 24 stocks that Goldman says could outperform the market and other cyclicals if economic conditions continue to improve.
“Although the equity market has started to price an acceleration in US economic growth, we believe the recent rotation has room to run,” Kostin continued.
Evercore ISI analyst Dennis DeBusschere agrees with Goldman Sachs’s assessment. DeBusschere said that the rally in cyclical stocks over the last few months has been driven in large part by hedge funds unwinding their positions against deflation as recession risks faded.
And with the macro environment improving, DeBusschere sees investors wanting to shift their focus toward earnings growth, which is good news for cyclicals.
But while financials and energy stocks are cheap, DeBusschere says the same isn’t true for all cyclical sectors as communication services, industrials, consumer discretionary, and technology are looking pricey. However, the analyst also notes that the outlook for cyclicals is more attractive than that for value as cyclicals should see more of a direct benefit from improving economic conditions.
“Value outperformance can fade while Cyclicals continue to outperform Defensives,” DeBusschere said.
The names that made Goldman’s list of 24 cyclical stocks are Acuity Brands (NYSE: AYI), Tapestry (NYSE: TPR), CBS (NYSE: CBS), CommScope Holding (NASDAQ: COMM), Evercore (NYSE: EVR), East West Bancorp (NASDAQ: EWBC), Lincoln National (NYSE: LNC), TCF Financial (NASDAQ: TCF), American Airlines (NASDAQ: AAL), Signature Bank (NASDAQ: SBNY), Zions Bancorp (NASDAQ: ZION), Middleby (NASDAQ: MIDD), Snap-On (NYSE: SNA), Harley-Davidson (NYSE: HOG), Urban Outfitters (NASDAQ: URBN), Crane (NYSE: CR), Kohl’s (NYSE: KSS), 3M (NYSE: MMM), Prudential Financial (NYSE: PRU), Toll Brothers (NYSE: TOL), MetLife (NYSE: MET), Lear (NYSE: LEA), W.W. Grainger (NYSE: GWW), and Prosperity Bancshares (NYSE: PB).
Overall, the median stock in the group trades at a substantial valuation discount to the market with an average price/earnings ratio of 11 compared to the Russell 1000 index’s 19, and is nearly 20% below its own five-year average.
But of these, analysts say CBS and CommScope have the most upside ahead, with the average Street price target indicating 31.58% and 33.61% upside over the next twelve months, respectively.