Is the Sudden Shift Into Deep Cyclicals Legit?

Posted: Nov 04, 2019 6:55 AM

The major stock market indexes have entered November with fresh gains, with the S&P 500 and the Nasdaq Composite setting new record highs following better than expected employment data and better than feared manufacturing data for October.

Nonfarm payrolls exceeded expectations, growing by 128,000 last month even during the General Motors (NYSE:GM) strike. Figures for August and September were also revised higher, while average hourly earnings rose 0.2% as expected. These facts suggest that the economy can continue to expand from a resilient labor market.

Friday’s release of the ISM Manufacturing Index for October remained below the 50.0% expansion/contraction line, but the 48.3% reading was viewed as better than feared as stocks pushed higher soon after its release. There was an almost 180-degree reversal of Thursday’s sell-off that was tied to negative commentary regarding China’s skepticism about the prospects of a long-term trade agreement with the United States. However, the market is in the process of taking two steps forward for every step backward, thereby grinding out new highs.

One new catalyst that totally defies the global growth narrative is the sudden high-volume breakout in the deep cyclical sector. Stocks belonging to steel, materials, mining, chemicals, railroads, heavy equipment and machinery companies charged higher in Friday’s session — led by a 17.3% spike in U.S. Steel (NYSE:X). Could it be that these stocks, which had once been left for dead, are putting in more than a one-day, head-fake rally?

It is hard to say, given the negative factory data both here and abroad, but in a market dominated by quantitative analysis where earnings momentum must be evident to warrant the purchase of a stock, the deep cyclicals could move 30%, 40% or 50% higher before the “quants” pick up on them. The biggest problem with quantitative modeling is that it omits the power of a change in perception that can become reality almost overnight.

With so many fund managers under-invested and looking where not to chase stocks with big gains like Apple Inc. (AAPL), it could just be a time where the perceptions of the domestic and global economies pick up speed in the fourth quarter and into 2020. This view got some support when the Fed noted it had moved to a neutral stance at last week’s Federal Open Market Committee (FOMC) meeting — followed by an uptick in bond yields.

For income investors who want to consider the deep cyclical trade, there are several big names in the sector that sport very attractive yields:

BHP Group (NYSE:BBL) — Yield 5.31%

Dow Inc. (NYSE:DOW) — Yield 5.35%

Rio Tinto PLC (NYSE:RIO) — Yield 6.14%

Weyerhaeuser Co. (NYSE:WY) — Yield 4.57%

One day doesn’t make for a trend, but the move that occurred late last week is highly notable and should not be ignored. I’ve noted in recent weeks that the rally in the banks, construction and semiconductor makers have enjoyed first-mover status and are still trading in a bullish manner. However, the early and easy money has been made. If the American and global economies are indeed on the verge of reversing course and picking up, then the profit opportunities for the deep cyclicals are more reality than perception.

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