Cyclical sectors that avoided bankruptcy during virus lockdowns "may currently be positioned with the greatest upside profit leverage," said Jim Paulsen.
Brendan McDermid/Reuters
The S&P 500's brief correction opened the door for a shift to neglected corners of the market, James Paulsen, chief investment strategist at The Leuthold Group, said in a recent note.
The benchmark index fell enough Thursday morning to temporarily sit 10% lower from its early September record. The short-lived correction was made possible by tech-led declines staged over the month. After the high-flying mega-caps pulled major indexes out of their coronavirus-induced losses, investors balked at their lofty valuations and kicked off a wave of profit-taking.
Paulsen now expects cyclical sectors and value names to fuel the market's next upswing. The lagging groups "seem poised to take a more significant leadership role in this bull market," he wrote in a note to clients. The S&P 500's most recent tumble "may represent an opportunity to 'broaden your bets,'" he added.
Value and cyclical stocks typically outperform once an economic expansion finds its footing. The market hasn't yet flashed that signal, as tech giants continue to anchor major indexes. Yet potent stimulus efforts and economic data suggest the rotation away from growth names will arrive soon.
Monetary and fiscal policies have a perfect record of ending the US's eight previous recessions within 12 months of their implementation, Paulsen said. Between the Federal Reserve's rapid easing measures and March's CARES Act, annual money supply growth in 2020 is set to repeat the trend and usher in a strong period of economic growth.
"Given its perfect record of lifting the US economy into a new expansion, and, considering the outsized degree of accommodation being provided today, it seems like a good bet to expect an economic recovery in 2021," Paulsen said.
Though the upcoming recovery will extend the aforementioned record, it's also likely to surpass growth seen in recent history. Analyst estimates for the next four quarters suggest the firms slammed the hardest by the pandemic will surge on the biggest GDP bump of the post-war period, according to Paulsen.
The cyclical companies that avoided bankruptcy during the coronavirus recession "may currently be positioned with the greatest upside profit leverage," he said.
Consequently, defensive stocks will likely underperform as investors take on more risk and pivot to names rebounding from the coronavirus recession, Paulsen added. Those keeping positions in tech giants will fall significantly behind those who moved cash into value and cyclical bets.
"Their steady-Eddy character is too bond-like during an economic boom," Paulsen said.
Investors shouldn't turn their backs on tech stocks entirely, the strategist noted. Popular members of the group still boast healthy fundamentals, and the coronavirus accelerated several trends set to lift the sector. Market participants should instead diversify holdings with overweight positions in small caps, value stocks, cyclical sectors, and international stocks to best profit from the upcoming expansion period, Paulsen said.
Now read more markets coverage from Markets Insider and Business Insider:
US new-home sales surge to fastest pace since 2006 as housing market shines through pandemic
JPMorgan slashes its forecast for US economic growth amid a lack of new stimulus
