The stock market correction seen in February could set the stage for some sectors to outperform, with Fidelity Investments highlighting those industries that are procyclical in that they tend to see growth in lockstep with the economy. In an interview in Fidelity Viewpoints, Denise Chisholm, Fidelity sector strategist, said that there are higher odds of outperformance in the current environment for procyclical sectors such as financials, technology, industrials and consumer discretionary than for other industries.
And that's even though stocks in these sectors have valuations that are high compared with other areas of the stock market. "These sectors were leading the market prior to the pullback and kept leading during the correction, so their valuations relative to the rest of the market increased," said Chisholm in the interview. "That said, according to my analysis, their relative valuations haven't gotten to the point that historically made them statistically less likely to outperform. And, being procyclical, they would be expected to lead when investors anticipate good economic and earnings growth."
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What's more, Chisholm said that all of the four sectors have growth drivers that have been attached to strong relative returns in years past. For financial stocks, it's the potential to see growth in loan volumes, while for technology companies, expanding margins will be the positive story. Meanwhile, industrials are likely to see increases in investment spending, and tax cuts are expected to drive consumers to spend more. All of this bodes well for the stocks in these sectors and signals that these industries may be able to outperform.
According to Chisholm, there is a high correlation between corporate profit growth of more than 5% and strong stock market returns. With corporations in the second year of a profit recovery, which tend to last anywhere from two to six years, the markets could be poised for more growth. She noted that the factor that affects the length of the profit cycle the most is the health of credit. The healthier the credit, the longer profit recoveries have lasted in the past.
"The current profit recovery began with a very healthy credit picture, as measured by metrics such as the percentage of nonperforming loans to bank assets and consumer delinquencies as a percentage of consumer loans," said the strategist at the Boston-based fund company. "That said, if credit conditions were to deteriorate, they could undermine the recovery in corporate earnings. If a situation like that developed at recent high valuation levels, it might be problematic for the market."