Cyclical stocks are typically bought on the notion that strengthening economic tailwinds will drive them higher. However, some cyclical stocks can outperform even when growth is in a soft patch, thanks to industry tailwinds that propel powerful product cycles. Thus, it is time to take a look at four bright spots within cyclicals: electrification, infrastructure and manufacturing construction, automotive, and semiconductors.
Recent US economic data releases point to below-trend growth but not to an incipient recession. The US jobs market is robust, interest rates are peaking, global inflation is trending down, and lower commodity prices are positive for many cyclical industries – the time is ripe to add some cyclicals to a portfolio. Our preference is not for any and all cyclicals, but for those that are supported by strong industry tailwinds and strongly supportive product cycles in order to add a margin of safety to our recommendation.
ELECTRIFICATION
The electricity grid infrastructure is undergoing structural changes. It is in need of major investments because it is ageing, but also because emissions targets have to be met and clean energy (solar, wind, hydroelectric, etc.) is much more distributed than traditional energy production (e.g. nuclear or coal power plants). In addition, the market share of clean energy is expected to double to more than 60% by 2030. On the demand side, the electrification of the economy, driven by increased connectivity, digitalisation, and e-mobility, means that demand for electricity will rise. Our focus here is on electrical equipment suppliers. While considered part of the ‘old economy’, they are essential enablers of the 21st century economy.
INFRASTRUCTURE AND MANUFAC TURING CONSTRUCTION
US manufacturing construction spending has doubled over the past twelve months to USD 189 billion. A key driver has been reshoring, as US companies look to diversify their global footprint, including by increasing operations in their home market. This is partly driven by the need to reduce exposure to global supply chain disruptions, but also by geopolitical tensions. It is also driven by a USD 5 trillion underinvestment in the US over the past two decades and the passage of the US Inflation Reduction Act, which will release further government spending. European companies are seeing similar trends in the need to have a diversified global footprint, as well as the zeitgeist of having a strong presence in their original home market.
AUTOMOTIVE
Automotive stocks are typically not desired during a cyclical downturn, but this cycle is different. After three years of global car sales 15% below their 2019 peak, the car market is much more resilient in this economic downturn. Pent-up demand should allow for 5%–10% growth of deliveries in 2023, with margins still near record highs. At the same time, valuations are well below their historical averages. Despite the strong performance year-to-date, we see more upside.
SEMICONDUCTORS
Semiconductors are what makes the heart of an electric device beat. However, demand has historically been very volatile and it has been a leveraged play on consumer spending on electronics. However, semiconductors are becoming less cyclical, as technology is now almost ubiquitous and corporate spending plays a much bigger role – the latest driver being high demand for graphic processing units, fuelled by the rise of generative artificial intelligence. This should underpin demand for cutting-edge semiconductor companies even in a growth slowdown.
