Why Cyclical Stocks May Outperform In 2019

The stock market's steep sell-off has heavily penalized financial, industrial, technology, and energy stocks in recent months, falling 10% on average and more sharply than the S&P 500 Index (SPX). That may change. Strategas Research Partners forecasts that the S&P 500 will return about 12% over the next year, and that these same four battered sectors will be market leaders. “We are sticking with our bias toward cyclical sectors like financials, industrials, technology, and energy,” Jason Trennert, co-founder and chief investment officer (CIO) of Strategas, writes in a recent report, as quoted by Barron's. The table below lists prominent stocks that could rise as these sectors rebound.

Strategas notes that its case for these four sectors rests on their expectations of favorable developments in two vital policy areas, trade and interest rates. On trade, they argue that President Donald Trump's tough stance is a negotiating tactic. "This is simply the way a commercial real estate guy from New York does business," Trennert says, adding: "He's going to start with $120 a square foot even when he knows the market's at $80. Ultimately, though, a deal gets done." As a example, he points to how Trump's threats to pull the U.S. out of the NAFTA treaty with Canada and Mexico proved to be simply a means to reshape the agreement in a manner more favorable to the U.S.

Regarding interest rates, Trennert believes that investors have overblown fears that rate hikes by the Federal Reserve Board that might tip the U.S. economy into recession. The main purpose of these rate increases is to keep inflation in check, but Trennert sees inflationary pressures abating in key areas such as rents, medical costs, as well as oil prices, which have fallen from recent peaks. Also, U.S. GDP growth is projected to slow in 2019, which also should help to moderate inflation.

There is little risk of an economic downturn ahead, Trennert says. The real, or inflation-adjusted, federal funds rate is approximately 0% right now, he observes. Since 1960, he notes, a recession has never happened if the real fed funds rate is below 2%.

Meanwhile, Matt Maley, equity strategist at Miller Tabak, sees technical reasons for optimism about bank stocks. Noting that he has been "very bearish about the group all year long," Tabak recently told CNBC that the SPDR S&P Bank ETF (KBE) has plunged to its 200-day moving average. "That level is also the same level that we saw at its lows in 2017," he observed. The KBE was 21% below its 52-week high as of the close on Dec. 7. Maley sees that as an oversold situation and finds "good support" for the group at its current level

A key risk to Strategas' forecast is that trade wars drag on without a satisfactory resolution in 2019, which could further slow the economy, earnings growth and rein in stocks. Regarding bank stocks, if interest rate increases do indeed moderate, that could be a negative for bank earnings.