07.25.2013
By Terry Flanagan

Economic Weakness Favors Cyclical Stocks

The continuing weakness of the economic recovery is likely to favor cyclical stocks, analysts say.

“As economic data continues to be softer than expected, we are likely to see a rotation into stocks that are more interest-rate sensitive, such as consumer discretionary,” said Scott Migliori, chief investment officer of U.S. equity at Allianz Global Investors, at a press briefing on Thursday.

The US Federal Reserve will expand its balance sheet by roughly $1 trillion in 2013, but investors are becoming more concerned about the possible “tapering” of Fed purchases in the fall and the ensuing losses on long bond positions.

A 7% unemployment rate has been noted as a likely trigger for tapering, while 6.5% has been mentioned as a threshold for policy rate increases. Meanwhile, inflation remains below the 2% target, and any back up in mortgage rates is likely to cool final demand growth further.

“There is growing concern about the impact of rising mortgage rates on the economic recovery,” Migliori said. “While most companies are reporting earnings in line with or better than estimates, a large number are missing estimates on the top line [revenues] which could be a sign that the Fed will not begin tapering until December at the earliest.”

Headline inflation should remain well behaved in 2013 and is likely to end the year near 1.5-1.75% after falling below 2% for much of 2012.

Inflation appears unlikely to be a catalyst to end the global recovery in the foreseeable future.

“Growth could extend for a longer period of time before inflation expectations act as a catalyst to hasten the next cyclical recession,” said Stuart Freeman, chief equity strategist at Wells Fargo Advisors, in a research note. “For this reason, we continue to encourage long-term investors to use any domestic market weakness this year as opportunities to build overweight positions in the more cyclically oriented versus defensive sectors” such as consumer discretionary, industrials, and information technology.

Sifma’s Economic Advisory Roundtable released its outlook for the second half of 2013 and predictions for 2014, forecasting that the economy will grow at a rate of 1.7 percent in full-year 2013 and 2.6 percent in 2014.

“Our Roundtable maintains their forecast for moderate economic growth for 2013 and 2014, with upside and downside drivers varied among respondents,” said Kyle Brandon, managing director and director of research at Sifma. “Generally, the continued housing recovery and low energy prices were seen as positive drivers of growth, while external factors such as Europe and emerging markets featured as the downside risks to the economy.”

Three-fourths of respondents expect the Fed to reduce the pace of securities purchases as early as September 2013, with the remainder expecting a reduction sometime in the fourth quarter of 2013 or at the latest January 2014, an assessment noted by Chairman Ben Bernanke in his semiannual monetary report to Congress.

Opinions diverged slightly more when asked about timing for the end of securities purchases, with over half expecting an end in the second quarter of 2014, slightly less than a third expecting an end in the first quarter of 2014, and the balance in the third quarter of 2014.

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