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Cyclical Stocks Gaining Favor Amid Frothy Market

NEW YORK (TheStreet) -- Cyclical stock are winning favor as the economy shows signs of growth and fund managers seek richer opportunities.

Consumer staples and insurance have helped fuel the Standard & Poor 500's meteoric climb this year, notching between 30 to 37% in 2013 while cyclical sectors real estate and technology hardware have posted more subdued returns of between 4 to 11%. The S&P has advanced 24%, poised for its best performance since 1997.

But fund managers warn that rising valuations among defensive sectors coupled with an ongoing economic recovery translates into a better outlook for cyclical names. Money managers cite the likelihood of a fresh capital expenditure cycle - investment by corporates for growth rather than hoarding cash - as a potential trigger for better returns in cyclicals. 


Jeffery Saut, Raymond James chief investment strategist, said his recent tour of the struggling Detroit area showed evidence of the pick-up with auto-plants working in overdrive.

"We are going to get a capital expenditure cycle in 2014 that will lift GDP towards 3%," Saut said in a phone interview. "And never underestimate the ability of the American consumer to spend money, even if they don't have it." Saut likes the consumer discretionary and energy sectors, citing stocks such as Apple (AAPL - Get Report), Tempur Sealy (TPX), Weyerhaeuser (WY - Get Report) and The Fresh Market (TFM) as presenting solid potential. Florida-based Saut helps oversee $400 billion in funds. 

Others cite the rebound in manufacturing data as reason to back cyclicals. 

"In general, cyclical companies are cheaper than defensives and stand to benefit more from any improvements to the global economy," Russ Koesterich, BlackRock's global chief investment strategist said in a note this week.

Koesterich said a rotation toward cyclicals had already begun - with these stocks gaining around 4.5% or roughly double as much as defensive sectors over the past three months. Koesterich, who helps oversee $4 trillion in funds, likes the IT and energy sectors along with U.S. manufacturers (such as chemical companies) that benefit from lower energy costs.

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Some predict a longer timeframe for any uptick in cyclical stock returns, noting economic data remains mixed.

Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management, expects third and fourth quarter economic growth to remain subdued at between 1.6 to 1.8%. As such, he prefers a mix of defensive and cyclical sectors, such as industrials and information technology stocks, utilities and telecoms. The strategist, who helps oversee $236 billion, says valuations were hard to justify on both consumer discretionary and staples stocks - the latter trading at 17.2 times forward earnings.

Longer term, Jacobsen backs a brighter outlook for cyclical sectors on the basis of ongoing improvement in manufacturing, employment and economic growth. "Economic data is choppy now but it's more a positioning for 2014," Jacobsen said in a phone interview. 

Even a modest increase in global growth should be sufficient to boost prospects for cyclical stocks, James Gaul of Boston Advisors said.

"Relative gains in defensive sectors are going to be limited [and] we're coming to a point where we will see whether multiple expansion [the rise in many defensive stock prices on the basis of higher earnings expectations] has been justified," the portfolio manager said in a phone interview. Boston-based Gaul helps oversee $2.5 billion in funds.

Nonetheless, skeptics remain. Scott Armiger, chief investment officer at Christiana Trust, pointed to a softening in global growth.

"Europe has barely emerged from its recession while US data shows weakening confidence and lower inflation," the Delaware-based manager said in a phone interview. Armiger, who helps oversee $8 billion in funds, is backing consumer staples, healthcare, and stocks such as CVS and CostCo. "We were pleased with the performance of staples in October and we're not ready to jump into cyclicals in a big way," he said.

--By Jane Searle in New York

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