Market Extra: A ‘sharper cyclical rally’ could be in the cards, this analyst says

Even though Congress has so far failed to come to an agreement on extending coronavirus fiscal aid, one analyst believes there’s upside for the stocks that have so far been left out of the rally since the March lows.

“Improved fiscal package four negotiations, implied real
rates plunging on anticipation of the Fed adopting inflation averaging, and
decelerating COVID case growth, (and) hospitalizations all support Cyclicals and
smaller caps,” wrote Evercore ISI’s Dennis DeBusschere.

There’s some bad-news-is-good-news thinking in DeBusschere’s analysis. Central banks around the world are buying huge swathes of the bond market, leading to what he calls “persistently negative real rates,” a topic MarketWatch explored this weekend.

With bond yields so low, it takes less for investors to
calculate that riskier assets offer a better return. The decline in the equity
risk premium is happening at the same time as earnings growth is improving,
DeBusschere noted.

As for the virus, DeBusschere argues that “Investors are looking through the second wave and increasing 2nd wave hot spot deaths to an easing of the virus as social distancing measures take effect.” One closely watched model suggests COVID-19 deaths are estimated to peak this week with a 7-day moving average of 1,110.  

The elephant in the room is still fiscal support, however. “A 10% unemployment rate and near record savings rate necessitates additionally fiscal stimulus to offset the continuing economic drag from COVID,”  DeBusschere  noted. “Otherwise, the recovery will be slow until a vaccine becomes available and widely distributed.”

For now, markets are still pricing in a stimulus deal, he added, “though patience may wear thin if negotiations remain stalled through next week.” All is not lost for stocks if there’s no additional stimulus, he said: even if growth slows, the mega-cap tech stocks

that benefit from work-from-home and social distancing backdrops will still outperform.

Assuming some sort of stimulus package is passed, DeBusschere sees big upside for energy and financials, and muted upside for materials and industrials. If investors do rotate their exposure, it would mean big potential downside for utilities and REITs, and slowing gains for the consumer discretionary and staples sectors.

It’s important to note that investors have anticipated for some time a rotation away from the perennial winners like tech and into sectors like energy and financials that aren’t as highly valued. During a few trading sessions over the past week or so, it’s almost seemed to be at hand.

Other themes that will benefit in this regime, DeBusschere says, are hard assets, like gold, and the housing market
which is getting a tailwind from lower financing costs and sturdy demand.

See: Gold will top $3,000, says this firm, one of the first to call the gold bull market of the 20th century