Morning Notes — The Good News About Cyclical Stocks

As noted yesterday, the S&P 500 successfully cleared technical resistance and the 250-day moving Volume Weighted Average Price (VWAP) of ~$298 for the SPY (SPDR ETF), a level (give or take ~2%) that typically leads to increased buying interest from systematic strategies. While those levels have technically been reached, we think the sustainability and extension from here depends on sector leadership. Specifically, near-term outperformance from cyclical/value groups (Consumer Discretionary, Industrials/Financials, Materials) would give us confidence around higher levels, while defensive sector (Consumer Staples, Utilities, Communication Services, Health Care) leadership would be a reason to look for consolidation before the SPX can extend higher.

The technical stuff above is good in the short-term, but our long-term outlook remains constructive based extremely favorable financial conditions. In a world of zero interest rates and sub-1% bond yields, a company’s earnings are discounted by a very low rate. From a present value perspective, it almost doesn’t matter if the economy recovers next year or in 2023…particularly when valuing a cyclical company. As I’ve said before, the good news about cyclical stocks is…they’re cyclical. A ten-year terminal value only cares about normalized cash flow and with such favorable financial conditions (including the largest liquidity boom in history) just normalizing cash flow feels far too conservative.