- The outlook for cyclical stocks has never been better, according to Bank of America.
- The bank said the Federal Reserve can shift its focus to economic growth after the cool June CPI report.
- "Slowing GDP + accelerating EPS has been the best backdrop for stocks," Bank of America said.
The cooler-than-expected June CPI report is fueling a "Goldilocks" economy that should benefit one specific corner of the stock market: cyclicals.
That's according to Bank of America, who said in a note on Monday that with the "inflation box ticked," the focus of the Federal Reserve will shift back to supporting economic growth from taming inflation.
"Headline inflation missed by 4.2 standard deviations vs. economists' estimates, the biggest miss in our data history since 1998. This confirmed our thesis that we're on the path to goldilocks, with macro and inflation back in sync," Bank of America strategist Ohsung Kwon said.
The bank said it expects a decline in June retail sales data, which is set to be released Tuesday morning, and that should further the Fed's case for interest rate cuts in September.
"Additionally, industrial production and housing starts should provide insight into economic activity. We think the economy is moderating not rolling over, but we expect our view to evolve with the data," Kwon said.
As long as economic growth moderates and the Fed gets started with its interest rate cuts, that should present a near-perfect scenario for cyclical stocks that are often found in the materials, industrial, energy, and consumer discretionary sectors, as well as some parts of the technology sector.
"The stars are aligning for the rotation into rate-sensitive cyclicals: rate pressure is easing, growth would ultimately be supported by the Fed, and most importantly, earnings are broadening out as the Other 493 comes out of an earnings recession," Kwon said.
The Other 493 refers to the S&P 500, excluding the "Magnificent Seven" mega-cap technology stocks, which include Apple, Amazon, Alphabet, Microsoft, Nvidia, Tesla, and Meta Platforms.
But for this dream scenario to play out, this second quarter earnings season needs to deliver.
While the bank expects a modest 2% beat on earnings per share this quarter, what's more important will be the backdrop of slowing economic growth and accelerating profit growth.
"Slowing GDP + accelerating EPS has been the best backdrop for stocks," Kwon said.