The U.S. economy is booming. After decreasing by 3.5% in 2020, the Bureau of Economic Analysis estimates that real GDP rose by an annualized 6.4% in the first quarter of 2021.
Contractions and expansions affect every sector, but the impact is amplified for cyclical stocks. Cyclical companies tend to ebb and flow with the broader economy. After paying their dues during the peak of the COVID-19 downturn in the second quarter of last year, many of these companies are now entering what could be a multi-year upswing.
Whether it's banks, tech, retail, or industrials, many stocks are cyclical in nature. Instead of conducting our conversation at 35,000 feet, let's narrow our focus to some of the most attractive investment opportunities right now.
Basic materials form the bedrock of an economic expansion. As the economy grows, so too does the demand for chemicals, metals, and minerals. Materials may not be the flashiest sector. But this year, many of these companies are crushing the market. The Materials Select Sector SPDR ETF, which tracks the sector, is currently at an all-time high.
From chemical stocks like Celanese to paint and coatings kingpins like Sherwin-Williams, there's a lot to like about materials stocks right now. But few materials have garnered as much attention as lumber.
An insatiable demand for new and bigger homes has led to record-high lumber prices. According to a recent report, lumber is adding an average of $35,872 to the cost of a new home compared to $24,000 just three months ago. Specialty REITs like Weyerhaeuser and pure-play buildings products and equipment companies like Louisiana-Pacific are just some of the many ways to invest in the lumber market.
Industrial stocks are synonymous with cyclicality. Aside from recession-resilient companies like Waste Management or diversified conglomerates like Honeywell, the industrial sector has the potential to outperform the market during good times and underperform during bad times.
Caterpillar (NYSE:CAT) is an excellent example of a coiled spring. The company's first-quarter results steamrolled past expectations as rising dealer inventories and upbeat guidance laid the groundwork for a rebound. However, Caterpillar is trading near an all-time high before the boom has even begun. In fact, Caterpillar's results suggest that its dealers are simply building their inventories back to pre-pandemic levels, not necessarily ramping up inventories for a surge in end-user demand. Demand could rise and make Caterpillar's stock look cheap, but the company noted that supply chain issues could limit its ability to meet customer expectations.
The tone is similar to what we are hearing from lumber companies. Demand is dynamic. Many companies who adjusted their operations to cope with the pandemic still have much of their workforce clocking in from home. Like many sawmills, Caterpillar's dealers want to take advantage of demand without sticking their necks out too far by overly increasing inventories.
What has been the best sector of the economy since the COVID-19 low? Not tech, not consumer discretionary, but transportation stocks. Specifically, package delivery stocks like United Parcel Service (NYSE:UPS) and FedEx (NYSE:FDX). Shares of FedEx have tripled in value from their pandemic low as the company's revenue soars to new heights. Its ground and freight segments are posting impressive operating margins that are fueling higher spending.
UPS is in a similar boat. Since reporting first-quarter earnings on April 27, shares are up a staggering 22% while the overall stock market has languished. UPS is transforming from a value stock to a growth stock as it leans into e-commerce and grows its international presence. Both FedEx and UPS are right around record highs. But unlike other cyclical stocks that are expected to boom, FedEx and UPS have been posting quarter after quarter of blowout results since the pandemic began.
A word of caution
Ideally, an investor would purchase cyclical stocks in anticipation of an economic expansion. Folks considering cyclicals now are at a bit of a disadvantage given that valuations have prematurely risen. Therefore, one approach could be to target top-tier names like Sherwin-Williams, Honeywell, Caterpillar, and UPS that have a track record for raising dividends and navigating downturns. Or take on a little more risk with a breakout growth story like Weyerhaeuser or FedEx. No matter how you slice it, the fat pitch has come and gone, so investors will have to pay a bit of a premium to invest in blue chip cyclical stocks right now.