Why BofA is bullish on the S&P 500's materials sector amid leadership shift in stocks

By Christine Idzelis

The materials sector outperformed the broader S&P 500 on Tuesday, as slumping tech stocks dragged down the U.S. equities benchmark

Bank of America strategists are bullish on the U.S. stock market's materials sector, partly because they're expecting an earnings rebound after the Federal Reserve began cutting interest rates in September.

"We raise materials to overweight," from "marketweight," as the Fed appears to be cutting rates into an "accelerating profits cycle," said equity and quantitative strategists at BofA Global Research in a note Tuesday. They also pointed to the Chinese government's recently announced stimulus program, saying materials had the highest correlation among the S&P 500's 11 sectors to the MSCI China Index.

The Fed started cutting its benchmark rate last month, after hiking it aggressively to battle high inflation, which now is down substantially from its 2022 peak.

"Materials saw the biggest earnings swoon of all sectors since hiking began, suggesting the biggest potential upside in earnings on an accelerating profits cycle amid Fed cuts," the BofA strategists said. Their note included the chart below, which tracks the trailing 12-month earnings of the S&P 500 index and its 11 sectors as of the second quarter versus 2021.

In overweighting materials, the BofA strategists also cited "a decade of underinvestment in manufacturing," with areas like mining and equipment replacement potentially driving higher returns. Spending in an "old school" cycle of capital expenditures, "alongside ambitious decarbonization goals," would generally support metals, mining and commodities, they said.

The S&P 500's materials sector gained 9.2% in the third quarter, beating the S&P 500's 5.5% rise over the same period, according to FactSet data. That pushed the 2024 gain for materials to 12.6% at the end of September.

MarketWatch reported Friday, as investors neared the end of September, that cyclical areas of the U.S. stock market had beaten technology over the past three months. Information technology is the biggest sector of the S&P 500 by far, with a 32% weight in the index, FactSet data show.

See: Stocks climb on week, with S&P 500 on pace for first September gain in 5 years

Meanwhile, the S&P 500's materials sector has been trading below its historical premium, according to the BofA note. The chart below shows the sector's price-to-earnings ratio versus the S&P 500.

The U.S. stock market kicked off the fourth quarter down Tuesday, with the S&P 500 SPX, Dow Jones Industrial Average DJIA and tech-heavy Nasdaq Composite COMP all closing lower after Iran's missile attack on Israel intensified geopolitical tensions in the Middle East.

The S&P 500's materials sector XX:SP500.15 finished 0.3% lower Tuesday, while information technology's XX:SP500.45 sharp 2.7% drop weighed heavily on the U.S. large-cap stock index. The S&P 500 index ended the trading session with a 0.9% decline, according to FactSet data.

-Christine Idzelis

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10-01-24 1647ET

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