Bank of America strategists are bullish on the materials sector of the U.S. stock market, partly because they anticipate a rebound in corporate earnings following the Federal Reserve's rate cuts that began in September. Stock and quantitative strategists from the bank's Global Research division stated in a report on Tuesday: "We upgrade the materials sector to 'overweight' as the Fed appears to be entering a rate-cutting phase of an 'accelerating profit cycle.'" They also highlighted the recent stimulus plan announced by the Chinese government, noting that the materials sector has the highest correlation with the MSCI China Index among the S&P 500's 11 sectors.
The Federal Reserve began lowering the benchmark interest rate last month after significantly raising rates to combat high inflation, which has now significantly receded from its 2022 peak.
"Since the Fed's rate hikes, the materials sector has seen the largest earnings decline among all sectors, indicating that this sector has the greatest potential for earnings upside in the context of Fed rate cuts and accelerating profit growth," said Bank of America strategists. Their report also included the following chart, showing the changes in the past 12 months of earnings for the S&P 500 Index and its 11 sectors compared to 2021, up to the second quarter.
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When overweighting the materials sector, Bank of America strategists also mentioned the "underinvestment in manufacturing over the past decade," suggesting that areas such as mining and equipment replacement could drive higher returns. They pointed out that metals, mining, and commodities typically receive support under a "traditional" capital expenditure cycle and "ambitious decarbonization targets." According to FactSet data, the S&P 500's materials sector rose by 9.2% in the third quarter, outperforming the S&P 500 Index's 5.5% gain over the same period, bringing the sector's year-to-date gain as of the end of September to 12.6%.
A report last Friday noted that as investors approached the end of September, cyclical sectors of the U.S. stock market have outperformed tech sectors over the past three months. According to FactSet data, information technology is the largest sector in the S&P 500 Index, accounting for as much as 32%.
Meanwhile, Bank of America's report pointed out that the S&P 500 materials sector is still trading below its historical premium. The following chart illustrates the sector's price-to-earnings ratio relative to the S&P 500 Index.
On Tuesday of this week, the U.S. stock market began trading in the fourth quarter, with the S&P 500 Index down 0.93%, the Dow Jones Industrial Average down 0.41%, and the technology-heavy Nasdaq Composite Index down 1.53%. The S&P 500's materials sector fell by 0.32%, while the 2.66% significant decline in the information technology sector put heavy pressure on the U.S. large-cap stock index.
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