Investment Research Update:
Fourth Quarter 2023

A strong economy may be good for stocks, particularly cyclicals

Fidelity's director of quantitative market research Denise Chisholm offers data-driven views of the markets, equity sectors, and other investment building blocks, such as factors and thematic strategies.

Key takeaways

  • The technology-heavy S&P 500 index gave back some of its year-to-date gain in the third quarter amid a stalling pattern in disinflationary trends and concern that the U.S. Federal Reserve may keep interest rates higher for longer.
  • Nine of 11 sectors in the index posted a negative return for the three months, with utilities and real estate leading to the downside.
  • Energy and communication services each posted a gain.

Strong rotations to cyclicals have had staying power

During the six months through July, investors shifted toward cyclical stocks and away from defensives. The size of this rotation was in the top 5% of all six-month periods since 1962. In this timeframe, the bigger the rotation into cyclicals, the more likely that rotation continued over the next six months.

Economic strength has been more important for stocks than rising rates

Over time, the health of the economy has had a more consistent influence on stock returns than the interest rate cycle. Since 1962, stocks posted double-digit gains, on average, in periods when inflation-adjusted economic growth accelerated, regardless of the rate environment. Cyclicals tended to perform better than defensive stocks during periods of accelerating real—that is, inflation adjusted—GDP growth, whether interest rates rose or fell.

Staples got cheap, but it may not be a positive sign

Consumer staples stocks‘ valuations have reached the bottom quartile of their range going back to 1977, based on forward earnings. This might not be a positive sign. Over the last 20 years, staples had only 45% historical odds of advancing in the 12 months after forward P/Es for the sector reached their historical least-expensive quartile, and 20% odds of an advance if earnings for the market were to accelerate in the next 12 months.

Rising capex to sales in energy could be a negative

The ratio of capital expenditures (capex) to sales for the energy sector has been near the low end of its range since 1962, although it‘s risen quickly year-to-date through August. Historically, the direction of the capex-to-sales ratio has mattered more than its absolute level. After it has risen sharply, the sector‘s performance has tended to slump.

EXHIBIT 1: Energy led the market in the third quarter, while investors moved away from utilities and real estate.

Past performance is no guarantee of future results. Sectors defined by the Global Industry Classification Standard (GICS®); see Index Definitions for details. Performance metrics reflect S&P 500 sector indexes. Changes were made to the GICS framework on 9/24/18; historical S&P 500 communication services sector data prior to 9/24/18 reflect the legacy telecommunication services sector. The top three performing sectors over each period are shaded green; the bottom three are shaded red. It is not possible to invest directly in an index. All indexes are unmanaged. Percentages may not total 100% due to rounding.

Source: Haver Analytics, Morningstar, FactSet, Fidelity Investments, as of 9/30/23.

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  • Views expressed are as of 9/30/23, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates.
  • This piece may contain assumptions that are "forward-looking statements," which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here. References to specific investment themes are for illustrative purposes only and should not be construed as recommendations or investment advice. Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk. This piece may contain assumptions that are "forward-looking statements," which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.
  • Past performance is no guarantee of future results.
  • Investing involves risk, including risk of loss.
  • All indexes are unmanaged. You cannot invest directly in an index. Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, and other expenses, which would reduce performance.
  • Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
  • Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with its particular industry.
  • The energy industries can be significantly affected by fluctuations in energy prices and supply and demand of energy fuels, energy conservation, the success of exploration projects, and tax and other government regulations.
  • The technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits.
  • The financials industries are subject to extensive government regulation, can be subject to relatively rapid change due to increasingly blurred distinctions between service segments, and can be significantly affected by availability and cost of capital funds, changes in interest rates, the rate of corporate and consumer debt defaults, and price competition.
  • The consumer discretionary industries can be significantly affected by the performance of the overall economy, interest rates, competition, consumer confidence and spending, and changes in demographics and consumer tastes. confidence and spending, and changes in demographics and consumer tastes.
  • Index Definitions
  • The Russell 3000® Index is a market capitalization-weighted index designed to measure the performance of the 3,000 largest companies in the U.S. equity market. The S&P 500® index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. S&P 500 is a registered service mark of Standard & Poor's Financial Services LLC. Sectors and industries are defined by the Global Industry Classification Standard (GICS). The S&P 500 sector indexes include the standard GICS sectors that make up the S&P 500 index. The market capitalization of all S&P 500 sector indexes together comprises the market capitalization of the parent S&P 500 index; each member of the S&P 500 index is assigned to one (and only one) sector.
  • Sectors are defined as follows:
  • Communication Services: companies that facilitate communication or provide access to entertainment content and other information through various types of media.
  • Consumer Discretionary: companies that provide goods and services that people want but don't necessarily need, such as televisions, cars, and sporting goods; these businesses tend to be the most sensitive to economic cycles.
  • Consumer Staples: companies that provide goods and services that people use on a daily basis, like food, household products, and personal-care products; these businesses tend to be less sensitive to economic cycles.
  • Energy: companies whose businesses are dominated by either of the following activities: the construction or provision of oil rigs, drilling equipment, or other energy-related services and equipment, including seismic data collection; or the exploration, production, marketing, refining, and/or transportation of oil and gas products, coal, and consumable fuels.
  • Financials: companies involved in activities such as banking, consumer finance, investment banking and brokerage, asset management, and insurance and investments.
  • Health Care: companies in two main industry groups: health care equipment suppliers and manufacturers, and providers of health care services; and companies involved in the research, development, production, and marketing of pharmaceuticals and biotechnology products.
  • Industrials: companies whose businesses manufacture and distribute capital goods, provide commercial services and supplies, or provide transportation services.
  • Materials: companies that are engaged in a wide range of commodity-related manufacturing.
  • Real Estate: companies in two main industry groups—real estate investment trusts (REITs), and real estate management and development companies.
  • Technology: companies in technology software and services and technology hardware and equipment.
  • Utilities: companies considered to be electric, gas, or water utilities, or companies that operate as independent producers and/or distributors of power.
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