Wall Street had a choppy ride in 2022 on rising interest rate concerns. Higher inflation expectations due to supply chain disruptions as well as higher crude oil prices prompted Fed members to pass several rate hikes over the past year. While Wall Street started 2023 on a positive note on signs of slowing inflation and slower Fed rate-hiking momentum, the volatility isn’t over yet.
According to the latest Fed minutes, interest rates will continue to rise amid ongoing inflation concerns, but at a slower pace, which Fed officials believe is the best way to manage the risks of a rate hike. At the same time, they are also concerned about halting or slowing down their anti-inflation campaign too soon. The central bank raised interest rates by 25 basis points last month after raising interest rates by 475 basis points last year, the fastest hike since the 1980s.
JPMorgan Chase chief executive Jamie Dimon said in an interview with CNBC on Thursday, as quoted by Reuters, that US interest rates could reach as high as 6%. No wonder the Nasdaq, which is heavily biased towards technology and growth stocks, was weak last year. Because the growth sector relies on easy borrowing for superior growth and its value is heavily dependent on future earnings, an increase in long-term yields lowers the present value of companies’ future earnings.
“Bear markets have historically led to leadership changes, suggesting that old economy sectors are likely to be the winners of this cycle,” Savita Subramanian, BofA’s head of U.S. equity and quantitative strategy, said in a note earlier this week , which was cited on Yahoo Finance. Bank of America indicated that its analysis of the equity risk premium shows that growth stocks are not pricing in recession risk.
However, there are signs of an impending shift in industry leadership. With that in mind, below we highlight a few sectors and their ETFs that are considered to be from the old economy. These sectors still offer cheaper valuation.
Sector ETFs in focus
Energy – Energy Select Sector SPDR ETF (XL – Free report) – P/E 16.64X vs. S&P 500 P/E 21.70X
Despite gaining as much as 30% over the past year, the XLE is still undervalued relative to the S&P 500. Investors should note that global recession fears are probably too great to be true. The IMF’s January 2023 World Economic Outlook Update forecasts that global growth will slow to 2.9% in 2023 but increase to 3.1% in 2024.
The forecast for 2023 is 0.2 percentage points higher than forecast in the October 2022 World Economic Outlook. The IMF’s higher forecast for global growth should bode well for oil prices. Also, China reopened its economy at the end of the Tiger year. This was a plus for economic activities. Meanwhile, Russia has curbed oil production. The Organization of the Petroleum Exporting Countries (OPEC) has also kept production under control.
Materials – Materials Select Sector SPDR ETF (XLB – Free report) – P/E 16.54X
The materials sector is rising due to higher material demand and is likely to continue its trend as the economy picks up steam. The sector has long been underinvested. The valuation of the sector (down 0.3% over the past year) is still cheaper even after beating the S&P 500 (down 5.7%) over the past year. Problems in the supply chain and high inflation will continue to drive up the prices of commodities and materials.
Residential – iShares US Home Construction ETF (ITB – Free report) – P/E 16.59X
This ETF also outperformed the S&P 500 in the past year (up 4.4%) and is still valued more favorably. The US housing sector is showing signs of improvement with builder confidence rising. Demand for homes has picked up, partly due to slightly lower mortgage rates. This is especially true as US homebuilder confidence rose for the second straight month to its highest level since September 2022.
The National Association of Home Builders/Wells Fargo builder sentiment indicator rose to 42 in February, the largest monthly gain in 10 years. Builders in all four regions reported increases in confidence (read: Homebuilder Confidence Rises Most in a Decade: ETFs to Tap).
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