Deep Cyclicals outperformed over the past month, especially Energy and Materials. Those sectors are rebounding after underperforming earlier this year and is part of a broader, though volatile, rotation into industries and factors that benefit from the combination of faster growth and stable financial conditions.
Deep Cyclical trends are usually more tied to the economic cycle and their recent recovery is aligned to the rebound in oil/other commodity prices. Energy and Materials have the highest sensitivity to both oil (CL1) and industrial commodity prices (CRB RIND). Oil prices have been volatile and macro trends over the past few years have encouraged rotations between Early Cyclicals and Defensives. That macro backdrop started shifting later in 2023, increasing the odds of a rebound in Deep Cyclicals.
Value and risk-on factors tend to be most positively impacted by oil and commodity price gains. Low Volatility and Quality, two factors that surged higher earlier in the year, are negatively sensitive to their commodity trends. While inflation is stable/trending lower, sensitivities to non-policy macro trends, should increase. For now, that encourages a rotation into Value/Risk and out of Quality/Low Vol. The shift in sensitivities has been playing out over the past four weeks.
Currently Energy remains positively exposed to Value and Growth, positioning it for the GARP rotation. Materials highest factor sensitivities are Momentum and Price Failure and its largest exposure is to Low Volatility, Cash Return, and Size. A rotation out of Momentum and Low Volatility would be a headwind for Materials as a group. Value sensitivity within Materials remains high, and that factor is aligned to the macro rebound paying out across the market.
Energy remains the sector most impacted by macro volatility. Roughly 70% of return can be explained by the first PCA, but that percentage has dropped recently. Materials are less impacted by macro volatility with the first PCA explaining ~42.9% of its volatility. That leaves stock picking more effective within Materials whereas Energy still tends to trade as a group.
Macro Rebound Tailwinds for Energy & Materials: Deep Cyclicals outperformed over the past month, especially Energy and Materials. Those sectors are rebounding after underperforming earlier this year and are part of a broader, though volatile, rotation into industries and factors that benefit from the combination of faster growth and stable financial conditions. Sector leaders from earlier in the year, including Tech, Industrials, and Health Care have given back some of gains.
Deep Cyclical trends are usually more tied to the economic cycle and their recent recovery is aligned to the rebound in oil/other commodity prices. Earnings fundamentals for Energy and Materials remained weak in 4Q earnings (HERE), but it is not uncommon that Deep Cyclical return trends diverge from their earnings growth. There are still room for catch up in commodity cyclicals given their depressed return since last year and recovery in the oil prices tailwind (HERE).
We ran S&P sector sensitivity to oil (CL1) and industrial commodity prices (CRB RIND). Energy and Materials have the highest sensitivity to both macro series. Interestingly, oil prices have had a much small than normal impact on Deep Cyclicals recently while commodity price sensitivity is higher than normal. Oil prices have been volatile and macro trends over the past few years have encouraged rotations between Early Cyclicals and Defensives. That macro backdrop started shifting later in 2023, increasing the odds of a rebound in Deep Cyclicals.
For factors, Value and risk-on factors tend to be most positively impacted by oil and commodity price gains. Low Volatility and Quality, two factors that surged higher earlier in the year, are negatively sensitive to their commodity trends. The macro backdrop remains highly sensitive to short rates and yield curve trends and overpowered the influence of other macro forces earlier in the year. As long as inflation is stable/trending lower, sensitivities to OTHER macro trends, should increase. For now, that encourages a rotation into Value/Risk and out of Quality/Low Vol.
The shift in sensitivities has been playing out over the past four weeks. Realized Growth and Comparative Value had the highest factor sensitivity within S&P Energy names. Currently Energy remains positively exposed to Value and Growth, positioning it for the ongoing GARP rotation. Materials highest factor sensitivities are Momentum and Price Failure. The sector is negatively exposed to most factors except Low Volatility, Cash Return, and Size. A rotation out of Momentum and Low Volatility would be a headwind for Materials as a group. Value sensitivity within Materials remains high, and that factor is aligned to the macro rebound paying out across the market.
Principal component analysis breaking down the market/macro impact (proxied by the first principal component) on sector volatility shows Energy remains the sector most impacted by macro volatility. Roughly 70% of return can be explained by the first PCA, but that percentage has dropped recently. Materials are less impacted by macro volatility with the first PCA explaining ~42.9% of its volatility. That leaves stock picking more effective within Materials whereas Energy still tends to trade as a group.
