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.


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