Will Cyclical Stocks Rally in September?

In August, cyclical sectors such as energy, financials, and industrials have fallen the most amid recession fears. The Energy Select Sector SPDR ETF (XLE) has fallen 9.6% and underperformed the remaining sector-specific SPDR ETFs. The Financial Select Sector SPDR ETF (XLF) and the Industrial Select Sector SPDR ETF (XLI) are down 6.4% and 4.7%, respectively.

Among sector-specific SPDR ETFs, only the defensive and high-dividend-yield sectors have risen in August so far. The Real Estate Select Sector SPDR (XLRE) is up the most. After XLRE, the Utilities Select Sector SPDR ETF (XLU) and the Consumer Staples Select Sector SPDR ETF (XLP) saw the next-highest rises.

Financial markets in August

So far this month, the S&P 500 Index (SPY) has fallen 3.1%. The tech-heavy Nasdaq 100 (QQQ) is down 3.3%. Safe-haven assets such as gold and the Japanese yen have risen 7.8% and 2.4%, respectively. The Swiss franc has also risen 1.2% against the US dollar in this period.

August is turning out to be the second-worst month for the equity market in 2019. In May, the S&P 500 Index saw a decline of more than 6%. During May, cyclicals led the decline. In the last five years, in three instances, the S&P 500 has either declined or remained almost unchanged in August. Only in two instances did the equity index rise between 3% and 4%.

Market rise without cyclicals

On August 27, Jim Cramer forecast a rally for the equity market in September based on the charts. For his analysis, he used the advance/decline line cycle forecast, the CBOE Volatility Index cycle forecast, and the S&P 500 E-mini cycle forecast. According to him, higher volatility in the market often indicates a bear trap.

Without a run-up in cyclical stocks, any rise in the equity market might not sustain. On August 28, oil showed a sign of recovery on a larger-than-expected draw in the US Energy Information Administration inventory data. Higher demand for oil will increase investor confidence in the energy sector. Cyclical stocks outperform when economic activity expands. Moreover, investors shift their portfolios to defensives amid uncertainty. Since the subprime crisis, among sector-specific SPDR ETFs, the Consumer Discretionary Select Sector SPDR ETF (XLY) has seen the highest rise. It’s up more than 400%. XLY is sensitive to the business cycle.

Morgan Stanley’s Mike Wilson warns that if investors have a higher percentage of cyclical stocks in their portfolio, it’s not too late to look at defensives. In fact, Morgan Stanley is underweight on cyclicals and overweight on defensives. Barclays has flagged similar warnings. In a recent note to clients, UBS Global highlighted the importance of investing in high-dividend-yield stocks. Moreover, the investment bank advised clients to accumulate gold. Over the next six months, UBS expects another rise of about $60 rise in gold prices from their last closing level of $1,543.