Our work suggests the economy is moving past the summer growth scare.
In today’s note, we provide the key factors behind this view and why we favor cyclical areas of the market as the economy sets up for positive surprises.
- The Atlanta GDPNow tracker currently suggests the U.S economy only grew 1.2% in the third quarter, down from an estimate near 6% on July 1. Downward revisions coincided with a surge in COVID-19 cases through the summer.
- The good news is the latest Delta variant wave appears to have crested, and we expect this should lead to better economic trends in the months ahead.
- The Citi U.S. Economic Surprise Index, which measures how economic reports come in relative to expectations, has declined sharply. However, as the COVID-19 numbers improve and economic data firms, we are already starting to see this index turn up from depressed levels.
The market is in sync with our view that we are moving past the summer growth scare as economically-sensitive areas rebound.
- Copper prices are up 15% this month, lumber prices are at a multi-month high, the transportation index has moved above a multi-month price downtrend, and the 10-year U.S. Treasury yield has continued to move higher.
- Classic defensive sectors continue to underperform, which also suggests investors are looking past the recent economic slowdown. The relative prices of the S&P Consumer Staples and Utilities sectors are near year-to-date lows. We remain underweight both sectors.
We remain overweight equities and continue to see opportunity in cyclical areas, including the energy and financials sectors, as well as small caps.
- While the S&P Energy sector is also up a lot this year, it remains 25% below where it was three years ago and has lagged oil prices, which are at the highest level since 2014. The sector also still trails the S&P 500 by 77% over the past three years. Thus, we still see upside as the economy firms.
- The S&P Financial sector made a fresh high recently. Improved economic trends and a gradual move higher in yields should remain supportive for the sector. Small caps appear attractive following extreme underperformance, 20-year lows in relative valuations, and strong earnings trends and should benefit from improved economic trends.
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