It might look as though U.S. stocks have been struggling since hitting a record high on May 21. Since then, the S&P 500 has fallen nearly 3 per cent amid concerns about the Federal Reserve's commitment to economic stimulus.
But hold on: When you look at the sector performance within the U.S. benchmark index, the most important trend of the past two months is persisting. That is, investors have a clear preference for economically cyclical stocks and are showing disdain for dividend-heavy defensives.
Since peaking at 1,669 in May, the S&P 500 has retreated 2.8 per cent. The decline interrupted what had been a steady rise since the middle of April, when the index blasted through its previous peak in 2007.
That April and May rally marked an interesting shift from the gains seen earlier in the year because it favoured financials, tech stocks, commodity producers, industrials and consumer discretionary stocks, with gains ranging between 9.5 per cent and 12.3 per cent. Meanwhile, the winners at the start of the year faded: Utilities fell, telecom stocks flat-lined, and consumer staples and health-care stocks lagged the index's performance.
The index has lost steam over the past nine trading days, but the underlying moves support the trend: While all 10 subindexes within the S&P 500 have fallen, cyclicals are faring far better during this bout of weakness. Tech stocks and financials show the best performance, with only slight declines. On the other hand, utilities have fallen a sharp 7.4 per cent and telecom stocks have fallen 5.6 per cent.
What does it all mean? The attractive valuations on cyclical stocks, relative to defensives, are drawing bargain hunters. As well, the decent U.S. economic reports of recent months – highlighted by rising employment, falling unemployment and a recovering housing market – make a bet on economically sensitive stocks look prescient.
But most of all, investors are growing concerned about a potential tapering of U.S. Federal Reserve stimulus – including rising interest rates – driving up bond yields and making dividend-payers look less attractive. The yield on the 10-year U.S. Treasury bond, for example, has been flirting with 2.1 per cent, up a steep half a percentage point since early May.
A number of strategists see bond yields continuing to rise. Credit Suisse believes the 10-year bond yield will rise to 2.7 per cent by the end of 2014.
That sounds as though it could continue to weigh on defensive, dividend-payers. Yet, Andrew Garthwaite, a strategist at Credit Suisse, remains bullish on the overall market. He raised his year-end target on the S&P 500 to 1,730, from 1,640. He believes the index will continue to rise to 1,900 by the end of 2014.
He argues that valuations are attractive, management is raising earnings forecasts for the first time in a year, investors are too pessimistic about Fed stimulus and more money from investors will flow into equities.
David Berman