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Ari Wald: Late Cycle Doesn’t Mean End of the Cycle

Mon, Jun 25, 2018 - 3:32pm

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Growth Versus Value Investing

The Fed signaled four likely rate increases this year, instead of only three, and this is likely to have a meaningful impact on the yield curve and specific sectors of the market, Oppenheimer's Ari Wald recently explained on our Financial Sense Newhour podcast.

The short end of the yield curve — which is more correlated to Fed policy — will continue to rise and, in turn, we’ll continue to see the yield curve flatten.

“If we examine the relationship between the yield curve and the value-versus-growth relative relationship, it's been very closely correlated in recent years,” Wald said.

“So as long as you're making the case for a continued flatness in the yield curve, you're going to continue to see growth sectors like technology, consumer discretionary, and small-cap healthcare, in particular, continue to outperform.”

The US Is Looking Strong Here

The recent strength we’ve seen in the dollar is going to hurt investors who own dollar-denominated ETFs that track both developed overseas markets and emerging markets.

We’re likely to see U.S. outperformance, Wald noted, both in local currency terms and dollar-denominated terms. This argues for investing in the U.S. rather than overseas equities, he added.

us dollar
Source: Stockcharts.com; Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly

Consumer discretionary is also doing surprisingly well overall, both in cap-weighted and equal-weighted segments.

This area of the market had been an underperformer from 2015 to 2017 and is really taking a noticeable leg up with traditional retailers such as Macy’s and Home Depot, in particular, leading the way.

“On the flip side of that equation, more defensive countercyclical sectors with a high dividend such as consumer staples have been underperformers,” Wald said. “That's a key point for us. This healthy risk-on appetite market preference for consumer cyclicals over consumer countercyclicals I think is a key positive and argues for an extension of the advance that we're in.”

The End Isn’t Nigh

Though we’re seeing signs of late cycle market action, this doesn’t mean equities are a bad bet here. The trick is likely to be picking the right index, or picking individual stocks here.

“As the age of the economic cycle continues to mature and we push into more late-cycle conditions … what we're seeing is that underneath the surface, the market trends are becoming much more uncorrelated and bifurcated,” Wald said. “I think it really puts the emphasis on active selection here.”

At some point, we will see the yield curve invert, Wald noted, which usually means a recession is around a year away, but he noted that we’re not there yet and it does us no good to try to lead the leading indicator.

With the advance-decline line at a new high and with small caps at a new high, Wald noted, this argues against a market top forming without the inversion in the yield curve, and for below average recession risks.

“When you add it all up, we're in a late cycle, but late cycle doesn't mean the end of the cycle,” he said. “I think these (sector) rotations are going to continue to develop. I think it's going to lead to an extension of the bull market. I think investors have to participate right here and I think exposure to stocks is warranted. We'd be putting money to work in those more cyclical areas of the market.”

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