U.S. cyclical sectors could shine in 2021 as they lead profit turnaround

NEW YORK, Dec 21 (Reuters) - Investors are looking for an economic and earnings recovery from the coronavirus pandemic to fuel gains in energy, financial and other cyclical sector stocks next year that could build on the late 2020 rally in the shares of those groups.

The lead up to and early distribution of COVID-19 vaccines have driven up shares this quarter in these sectors that usually thrive during cyclical upswings.

The trend is especially apparent in the S&P 500 energy index, which is up 29% for the quarter so far, leading gains among the 11 S&P industry sectors, followed by financials , up 18%, and S&P industrials, up 15%.

Many strategists at the biggest investment banks including Goldman Sachs, BofA and BMO Capital Markets have at least some cyclical sectors as their top recommendations for 2021, arguing that these groups will largely outperform defensive sectors such as utilities and consumer staples.

“You’re going to see earnings recover, the economy recover and that’s all on the back of the cyclicals and restocking,” said Tim Ghriskey, chief investment strategist at Inverness Counsel in New York.

That’s partly why cyclicals have been rallying, but that rally is not over, he said. “The market will transition from all growth to more of a balanced market between tech and cyclicals, and we really see that continuing as we get closer to mass distribution of the vaccine.”

Even with the recent gains, energy is down 36% since Dec. 31 and on track to be the year’s worst-performing sector, and financials are down 8% in that period. Information technology is up 40% for the year to date, leading S&P sector gains.

And even though many strategists are recommending some cyclical sectors for 2021, they also like technology, the S&P 500’s most heavily weighted sector.

While news of the vaccines has brought cheer, virus cases are still surging especially in the United States and the vaccine distribution process could take many months.

For stocks, “the risk is likely to the downside in the near term because of all of the optimism that’s baked into the market,” said Ohsung Kwon, U.S. equity strategist at BofA Global Research.

But there’s more room to run next year, especially for financials and energy, he said.

“Our top sectors for next year are financials and energy, which are seen as deep value sectors and those are more beaten down. We think the next leg of the rotation into value and cyclicals will be those sectors.”

BofA last month lifted its rating on the energy sector from underweight to overweight.

Cyclicals have had the biggest year-over-year drops in earnings this year thanks to the coronavirus’ impact on consumers and businesses, and are projected to lead a profit recovery in the S&P 500 next year, according to IBES data from Refinitiv.

The economy is expected to rebound as businesses fully reopen and consumers resume regular activities. Kwon said spending will shift toward services including hotels and travel.

Earnings for S&P 500 companies are forecast to rise about 23% in 2021 over 2020, with energy seen jumping more than 600%, industrials climbing 79% and consumer discretionary gaining 58%, the data showed.

Still, cyclical recommendations vary greatly among strategists, and many are concerned optimism may be overdone.

Jonathan Golub, chief U.S. equity strategist at Credit Suisse Securities, is overweight financials for 2021, but is neutral on cyclicals in general.

On cyclical recommendations, Goldman Sachs is overweight industrials and materials and neutral on consumer discretionary, financials and energy. BMO Capital Markets is overweight consumer discretionary, financials and industrials, while it is marketweight on materials and underweight energy.

“While the cyclical ‘green light’ in terms of both the stock market and economic recoveries remains early, we believe industrials will be a primary beneficiary of a broader cyclical recovery,” Brian Belski, chief investment strategist for BMO Capital Markets wrote in his 2021 outlook.

Reporting by Caroline Valetkevitch; Editing by Alden Bentley and Lisa Shumaker