Bank of America made a strategic call by upgrading the Consumer Discretionary sector from Underweight to Overweight while simultaneously downgrading Consumer Staples from Marketweight to Underweight.
In a note shared Monday by equity analysts, including Savita Subramanian, the key driving force behind the upgrade in the Consumer Discretionary sector is the latest assessment by BofA economists, who are now projecting a favorable outcome for the U.S. economy.
Improved Economic Outlook, Light Positioning Favor Discretionary
Their prediction includes a "soft landing," eliminating the threat of a recession, and a substantial increase in U.S. consumption growth expected for the year 2024. The bank's revised projections for GDP growth demonstrate an upward trajectory with 2% growth in the fourth quarter of 2023 and 0.7% in 2024, both exceeding prior forecasts by 0.5 and 0.7 percentage points, respectively.
The Bank of America's economic cycle tracker surged in July, indicating the potential emergence of an Early Cycle phase.
Historically, this transition favors a style rotation towards more cyclical industries, with Consumer Discretionary - also tracked by the Consumer Discretionary Select Sector SPDR Fund
- typically outperforming during this phase, while Consumer Staples - also tracked by the Consumer Staples Select Sector SPDR Fund
A significant factor contributing to this strategic shift is the unprecedented positioning in Consumer Discretionary, with active funds holding historically low relative weights within the sector.
End of Fed Hikes Looms
Bank of America's analysis also reveals an intriguing historical pattern: the end of Federal Reserve rate hikes has often coincided with the bottoming out of Consumer Discretionary, marking the beginning of a recovery period for the sector.
Another promising sign for discretionary stocks is the return of real wage growth, a phenomenon not observed in the past two years, as inflation fades while a tight labor market supports real incomes.
Risks Associated To The View
Consumer Discretionary currently trades at a premium to historical valuation measures, which takes into account price-to-earnings ratios.
However, this premium appears to be more reasonable when excluding heavyweights Amazon Inc.
These two stocks constitute a significant portion of Discretionary's market capitalization (50%) and earnings (20%), which can influence the overall sector's valuation.
