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15 January 2021

A COMEBACK FOR CYCLICAL SECTORS?

Cyclical stocks were predominantly depressed last year amid the Coronavirus crisis, with profits taking a large hit as travel and face-to-face meetings came to a near halt. Travel and leisure, real estate, energy, and industrials traded lower in 2020, while sectors that are less dependent on economic conditions, such as technology and healthcare, have performed significantly better. However, following promising Coronavirus vaccine news, those sectors more sensitive to economic cycles have jumped as investors begin to shift their money away from high-flying tech stocks. As optimism over an economic recovery in 2021 continues to grow, energy, real estate and industrials are starting to look more attractive based on earnings expectations. According to Credit Suisse, the group is now expected to deliver a rise in profit growth next year, with projections that cyclical sectors could report more than 65% earnings growth in 2021.

The performance of markets recently has focused on the so called ‘value rotation’, with cyclical sectors outperforming defensive ones. Insurance, energy, and banks have recently been the best performers globally, up 21.1%, 16% and 16.7% respectively. Firms in the pandemic-hit leisure sector such as British Airways owner International Consolidates Airlines Group and Cineworld have seen their valuation surge by 50% or more over the last couple of weeks and companies such as Whitbread, TUI and Carnival also producing strong gains, up more than 30%.

Energy is usually one of the industries which benefits from a shift in sentiment, however, since the Coronavirus pandemic began the energy industry has started to undergo a structural change as many countries across the world use the pandemic as an opportunity to enact more green policies and shift towards renewables. Initially, when the pandemic broke there were fears that the inevitable economic recession would hinder efforts to move towards a carbon-neutral future. However, the crisis has only underlined the importance of ensuring that the economy remains both sustainable and resilient in the long term. Worldwide lockdowns dramatically reduced the demand for oil and gas, however, they provided a significant boost for renewables. Following a sharp drop in fuel prices, renewable energy companies became more competitive with ever-falling renewables prices and fossil fuel companies beginning to turn towards wind and solar energy sources. Furthermore,  traditional forms of energy are likely to encounter further scrutiny following the election of Joe Biden, who placed climate change at the forefront of his campaign and has now encouraged five of the UK’s biggest energy companies to lobby Boris Johnson to match his clean energy goals. Given that oil and gas companies are facing tougher headwinds from regulations, and from a shift in political capital invested to push forward green energy, a cyclical value into the sector, may be hard to envisage.

On the other hand, the Coronavirus crisis is the most significant challenge that the travel and leisure sector has faced in recent years, with markets essentially unable to operate. Government restrictions across the globe have had a seismic effect on the industry, pushing it into hibernation. Since last March, the focus for the sector has been to survive rather than to thrive, forcing many companies to reassess and reshape their business models in order to cope and recover during such challenging times. Analysts, however, are becoming increasingly bullish on the sector, pinning hopes on a vaccine-fuelled recovery that will benefit the industry later this year and into 2022. Although travel is unlikely to return to normal levels until the vaccine is widely available, air travel and subsequently the overall leisure sector will pick up significantly, with travel potentially seeing a 50% recovery by the second quarter of 2021. As progress towards Coronavirus vaccines is helping investors look past the current frightening resurgence of infections, cyclical value is very much likely to return to the beaten-down travel and leisure sector.

Please note that investments and income arising from them can fall as well as rise in value. This communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.
 
A COMEBACK FOR CYCLICAL SECTORS?
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