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HomeMarketIf You're a Contrarian, Buy These 2 Types of Stocks  

If You’re a Contrarian, Buy These 2 Types of Stocks  

*** ONE-TIME USE *** Pigment is added to a gallon of ProMar 200 paint, an interior latex with zero volitile organic compounds (VOC’s), at a Sherwin-Williams Co. store in Princeton, Illinois, U.S.

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Daniel Acker/Bloomberg

The stock market won’t be sorry to say goodbye to 2022. It’s been a lousy year across the board, but especially for two groups of stocks: cyclicals and growth. They have been hammered in the past 12 months.

But the coming year could be their comeback if—and it’s a big if—the economy hangs tough and investors calm down. And for you Wall Street contrarians out there—those who choose to swim against the current —growth and cyclical names are what you’re looking for.

The drop for growth has been stomach-churning. The iShares Russell 2000 Growth Exchange-Traded Find (ticker: IWO) has dropped about 27% since January. Behind the fall is the rise in long-dated bond yields, in part a response to central banks raising short-term interest rates.

Higher long-dated yields make future profits less valuable, so fast-growing companies with a bulk of their profits expected to come years down the line take an outsize hit to their stock valuations. And growth companies that haven’t turned any profit yet face even more risk since higher rates make debt and equity financing more difficult, potentially leaving them without enough liquidity. 

Cyclicals have unequivocally felt the impact of the Federal Reserve’s steady drumbeat of rate increases, kicked off in March. The companies feel the hurt in sales and earnings when economic demand wanes, which is exactly the Fed’s goal in raising rates. Their counterparts are defensive stocks like health insurers and utilities, many of which are up.

More than a few materials stocks, for instance, have been knocked down. Shares of
PPG Industries
(PPG) and
Sherwin-Williams
(SHW)—both sell paints and coatings to households and businesses—are off at least 24%.

Bank stocks, too, have tumbled. The SPDR S&P Bank Exchange-Traded Fund (KBE) is off 20%. The threat of lower loan volumes with weaker economic demand—and potential credit losses from suffering consumers and businesses—have outweighed the higher interest rates banks are charging.

Now, all of these types of stocks could start turning upward. 

“Contrarians are currently long growth, bearish value and prefer cyclical to defensive sectors,” wrote Robert Buckland, global equity strategist at
Citi.
 

But why? For starters, evidence is building that bond yields could soon decline. Already, the 10-year Treasury yield, at about 3.46%, remains convincingly below its multi-year peak of just over 4.2%. That’s in part because the Fed has already begun reducing the size of short-term rate hikes, even though its projection in December showed that it could keep rates higher for longer than previously expected. And if the inflation keeps declining, as it has been since summer, the central bank could change its tune.

Lower inflation expectations also drag the yield downward. And lower yields would help growth stocks, especially ones that can hold their sales and profit growth trajectories. Overall, “easing inflationary concerns, and an associated peak in rates, might help their preference for growth stocks,” Buckland wrote. 

The same goes for cyclicals. If rates stabilize, or even head lower, the market can envision an end to the economic damage. To be sure, that’s dependent on lower inflation, which also hurts pricing power for cyclicals like materials. But stability in the demand would benefit these names—and the companies with the best pricing power and the most premium products and services can be the winners. 

But like so many things, there’s a caveat to the cyclicals play. Some still need earnings estimates cut since the full effect of higher rates on the economy don’t take effect right away—and analyst profit forecasts haven’t declined much yet.

Some are still expensive when adjusted for their potential drops in earnings. So they might struggle early in the new year. A rebound, though, could come as the months wear on—if the current macroeconomic and financial market conditions turn out the right way. 

There’s that if again. Now, we’ve left you with plenty to chew on for the final two weeks of 2022.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

Credit: marketwatch.com

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