Last week, cyclical stocks surged as investors digested the implications of an imminent and highly effective vaccine. Ironically, the prospect for a return to normal and the rush into companies tied to mobility spending, i.e. travel and leisure, represented a 180 degree turn from the previous week.
In the immediate aftermath of the election investors abandoned cyclicals, particularly banks, and rushed back into the warm embrace of secular growth stocks. Put differently, the past few weeks have witnessed unprecedented rotations, followed by equally violent reversals. For example, in the days immediately following the election, banks suffered through their worst day ever of relative performance; the following week they had their best. Which is it? Value or growth, cyclical or defensive? I’d stick with my answer from mid-August: high quality cyclicals, not deep value.
During the past three months market performance has been more nuanced than during the growth led rally of the spring and early summer. While U.S. growth stocks continue to outperform, many cyclical stocks have also been beating the market. Materials and industrials have been two of the best performing sectors. Even within sectors, we witnessed a similar pattern. Looking more closely at tech, semiconductors gained roughly 14% versus a more muted 5-6% gain for software, traditionally seen as less cyclical.
Even without new stimulus, the economy is improving
Looking back at the past three months, gains in cyclicals were supported by the anticipation of a Democratic sweep and a hefty, new dollop of stimulus. With the election behind us it has become obvious that, regardless of the results in the Georgia Senate runoffs, Democrats are unlikely to have the type of working majority that will lead to massive new stimulus. Where does this leave markets in general and cyclicals in particular?
While some additional stimulus is arguably necessary, the growing likelihood of a vaccine suggests that this may take the form of a temporary stopgap. In the meantime, the economy has momentum.
Since August the economy has created +900k jobs per month. Although this represents a slowdown from the summer gains, recent improvements have been enough to push the unemployment rate down to 6.9%. By comparison, during the last recession it took approximately three years for the unemployment rate to fall below 7%.
Falling unemployment, record low interest rates and solid household balance sheets translate into better-than-expected consumption. This can be seen in auto sales, which typically plunge during a recession. Only this time auto sales have already bounced back above 16m annualized, not far below the December 2019 level (see Chart 1).
Chart 1 - U.S. auto sales
Source: Refinitiv DataStream, Wards Intelligence and BlackRock Investment Institute, as of November 16, 2020.
Note: seasonally adjusted
Given this dynamic I would continue to favor high quality cyclicals, i.e. companies that are geared to the economy but are more profitable than their peers. From an industry standpoint, I would lean into rails, specialty chemicals, home builders, semi equipment and payment companies. While these names may, in the short-term, underperform the more speculative parts of the space, they all have staying power; quality and cyclicals are not necessarily mutually exclusive.