Weekly Update

Industrial/Cyclical Stocks Continue to Hold Up

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Published March 3, 2023


While the stock market broadly has struggled the past month, there are underlying signs of strength. This is not currently a stock market where all boats are rowing in the same direction. The chart below shows the Industrial sector stocks (in red). This group has held its advance from last Fall and has significantly outperformed the S&P 500 (the blue dashed line). One-third of the Industrials sector ETF (symbol: XLI) is comprised of only seven companies – Raytheon, Caterpillar, UPS, Honeywell, Union Pacific, Deere, and Boeing. If the economy were headed for a notable recession, we would expect these stocks to show weakness. But they are not, so far.

Contrast that to the green line below which is the Tech sector. This group, the market leaders over the past decade, has encountered quite a bit more volatility and is really struggling to hold on to its rally from last Fall. This is a case of valuation, to a significant degree, as rising interest rates have hit these highly-valued, high-growth stocks. The Tech stocks drive the broad market as you can see the tight correlation between the two lines (Tech in green and S&P 500 in light blue).

Technology sector is struggling to hold on its rally from last fall

The forward Price-earnings ratio for the S&P 500 is 18 on a projected growth rate of 12%. That’s a Price-Earnings-to-Growth (PEG) ratio of 1.5. Compare that to Tech at a P/E of 23 on a growth rate of 13% (PEG of 1.8). Industrials carry a P/E of 19 on a growth rate of only 8% (PEG of 2.3). So, the Industrials group is surprisingly expensive when looked at that way. To justify the premium they are receiving, we would expect their earnings growth to really accelerate. Almost all the companies in this group have posted earnings that were well-received. The group trades very near their all-time high.

Watch Industrials (XLI) for a good sense of whether the stock market can keep the bear’s claws away, or whether stocks have just delivered a “bear market rally” and will succumb to another round of selling.

Market Update

Stocks bounced back Monday from their worst week of the year as a smattering of company news and possible oversold market condition attracted buyers. Still, the lift was a very modest +0.3%. That small gain was reversed Tuesday as markets closed out a weak month of February. Coming off a powerhouse rally January, investors have been unnerved by a resumption of interest rate hikes that has pushed the 10-year U.S. Treasury yield back near 4.0% from 3.4% at the end of January. Inflation and economic data have both been stubbornly high leading investors to think interest rates might peak at a higher rate than previously thought. Strong manufacturing data released Wednesday furthered that narrative leaving stocks down -0.5% to begin March trading. However, strong economic reports from China brought positive investors responses with Hong Kong stocks rising +4%. Stocks reversed earlier losses Thursday after one of the Fed regional presidents expressed a firm conviction for a 0.25% rate hike at the Fed’s next meeting. Investors have been concerned that the central bank might be considering a 0.5% upcoming hike. The afternoon stock rally left the S&P 500 higher by +0.8%. Friday brought more positive economic data. However, this time, when coupled with Thursday’s reading of a 0.25% upcoming Fed move, investors took the strong economic data as good news – global economic strength just might overcome higher inflation if interest rates don’t take another leg higher. Stocks started the day reacting positively to the strong service sector report and never let off closing Friday with a +2% gain on the Nasdaq 100 (QQQ) as interest rates surprisingly dropped back.

A slack first half of the week gave way to a strong Thursday/Friday move for stocks to give indexes their first gain in four weeks. The S&P 500 (SPY) rose +1.97% for the week, recovering all of the prior week’s downdraft. The Nasdaq 100 (QQQ) notched a +2.68% weekly gain to close just shy of the 300 level that has been important over the past month. Smallcap stocks (IWM) gained +2.13% on the week.

Warm wishes and until next week.