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Rise of the US cyclicals

After a very wobbly start to the year, US cyclical equities appear poised to rise.

Recession fears and lacklustre business confidence have been giving certain US cyclical equities a rough ride for some time now. However, attractive prices and indications that the US economy is not on the cusp of a recession after all now make cyclicals an interesting proposition.

Cyclical equities, or just plain cyclicals, are equities that are sensitive to the economic cycle. In other words, corporate earnings in this sector are sensitive to the general state of the economy. Cyclicals include equities in the auto industry, the tech sector and construction, all of which offer products or services that are down-prioritised when the economy stalls or grows slowly. In contrast, cyclicals greatly benefit when the economy is flourishing.

“One thing is seeing a stock that is priced cheaply. But if you can also spot a trigger for growth to return, then the potential pick up is even greater,” says Danske Capital analyst Jan Holst Hansen, who adds: "We now expect US cyclicals to outperform the broader market.”

Positive economic data
Indications of an improving outlook for the US economy have been multiplying, even in the past week.

ISM manufacturing data arrived last Tuesday (1 March). This is data from US manufacturers covering areas such as new orders, inventories and new hires – and this time it was something of a dream report. The ISM manufacturing index has been falling sharply for more than a year, but on Tuesday we could note that business confidence, for example, is rising again. It has now been on an upward trajectory for the past two months, while manufacturing firms have also reported increasing order books.

“This indicates that what has been the ‘problem child’ of the economy for many months is now finding its feet again. While the ISM is still low, we expect it to rise from here,” says Jan Holst Hansen.

From an investment perspective, Jan says the most attractive option would be to invest in cyclicals with substantial exposure to the US growth story. This could include construction, transport or consumer goods – including consumer technology.

Rate hikes looking more credible
Another factor that points to a positive environment for the US economy is that inventory reduction among US corporates should no longer be a headwind to growth. US corporates proved unduly optimistic last year with respect to outlook and expected demand and so ended up with very substantial inventories in a number of sectors. Naturally, those inventories had to be reduced, but the adjustment process now appears to be almost complete, which provides some scope for business confidence and growth to return, as was also confirmed by Tuesday’s ISM report, according to Jan Holst Hansen.

A third factor indicating future growth in the US is increasing market expectations for a rate hike from the US central bank – the Fed. Cyclicals have historically performed better than defensive stocks when interest rates are hiked.

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