David Joy: Cyclical sectors get a boost

The S&P 500 climbed 1.2% last week, its first gain in the past three weeks. It was enough to push the index to its first-ever close above 1900.

Contributing to the improved sentiment was evidence that the housing market may be awakening from its winter slumber. Both new and existing home sales rose in April, offering some hope that activity could be firming. Mortgage rates have fallen to 4.14% for a thirty-year conventional fixed-rate loan, according to Freddie Mac, the lowest rate since last October. Also helping was a jump in the number of properties for sale, and some moderation in the pace of price appreciation.

Investors were further heartened by a reported rise in the preliminary flash manufacturing PMI for May, the first increase following two months of modest declines. In addition, the release of the minutes from the April Fed meeting reinforced the notion that supportive monetary policy is likely to remain in place for the foreseeable future.

The strength in equities last week was led by more cyclical sectors, including consumer discretionary, which gained 2.1%, and technology, which rose 1.8%. Conversely, the laggards were the more defensive utilities sector, which fell 0.9% and was the only group to see a price decline, and consumer staples, which was flat on the week.

The reversal of form for consumer discretionary and utilities was striking in that utilities have been the best performing sector year-to-date with a gain of 10%, including last week’s loss, while consumer discretionary has been the year’s worst performing sector with a loss of 2.6%, including last week’s gain.

Bonds Unfazed

The bond market was far less responsive to last week’s economic news. The yield on the ten-year note rose just one basis point to 2.53%, while the yield on the two-year note fell two basis points to 0.34%. The yield on the Bank of America Merrill Lynch High Yield Master II index was unchanged at 5.96%.

Whether last week’s price action in stocks is the start of a long-awaited sustained outperformance by economically-sensitive names remains to be seen. For that to happen the data must continue to firm. And there is certainly a lot of data scheduled for release this week. Durable goods orders, home prices and pending sales, PMIs, regional manufacturing indices, personal income and spending, inflation, and consumer confidence are on the holiday-shortened calendar.

Overseas, there has been increasing concern that activity is slowing. First quarter growth in the Eurozone was less than expected, the Japanese consumer is absorbing a tax increase, and China is feared to be decelerating faster than it would like. However, in overseas trading on Monday, while U.S. and U.K markets were closed, Chinese stocks rose after Premier Li Keqiang said that policy would be fine-tuned to support the economy. And in Europe, stocks in Ukraine rose 4.9% following the election of a new president. Stocks rose throughout the Eurozone, further assisted by comments from European Central Bank President Draghi that reinforced expectations of further stimulus at the June 5 meeting.

In the absence of inflationary pressure, the Fed seems willing to press the case for further improvement in the labor market. If so, and if the economic data continues to improve, stocks seem poised to move higher. And if the accelerating activity ignites an upswing in capital investment and steady improvement in housing, expect last week’s cyclical sector leaders to continue to outperform.

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The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks.

Bank of America/Merrill Lynch High Yield Master II is an index of high-yield corporate bonds which measures the broad high yield market.

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