UPS - Stocks To Watch If The Bear Gets Trampled

Summary

• There are some positive signs in the market, including a broad-based recovery, a rotation into riskier assets and a recent rise in customer margin.
• The inverted yield curve continues to provide headwinds for economic expansion.
• If the recovery continues, investors might look at companies that supply transportation and infrastructure products to support the overall economy.

By Erik Lytikainen and Robert Mc Bride

In addition to working in finance and data science, my business partner Rob owns a small family farm. He has a few goats, egg-laying hens (it is a six month wait to get more -- that's another story), and 10 head of cattle. He especially loves taking care of his cows -- they are beautiful, smart and surprisingly fierce.

Bulls and cows aren't afraid of bears. They will put up a fight, especially when protecting their young calves.

After enduring a bear market in 2022, stocks have enjoyed a nice rally to start 2023. We are seeing signs that point to a continuing rally, despite various economic and financial headwinds.

The positive signs for a continued recovery include: good market breadth in the recovery, a rotation into risker assets, and a recent increase in customer trading margin. If the recovery continues, longer-term investors might look at companies that supply transportation and infrastructure products to support the overall economy.

Inverted Yield Curve

Short-term interest rates are higher than longer-term interest rates, and this tends to stifle long-term investment and economic growth. Inversion in the yield curve at the moment is the highest it has been for at least 30 years, and yield curve inversion almost always precedes or coincides with a recession. The relative strength of the inversion can be seen in the chart below.

Market Breadth

The percent of stocks above their 200-day moving average is a common measure of market breadth and indicates that buying has not been concentrated to only a few names. Currently, more than 66% of the S&P 500 constituents are trading above their 200 day MA.

In late 2020 and early 2021, we can see that peaks in this measure of market breadth preceded the late 2021 top in the market. The recent rally has been broad-based.

Rotation Into Riskier Assets

XLY is an ETF which covers consumer discretionary stocks while XLP covers consumer staples. Part of a normal business cycle involves a rotation from risky stocks to safe stocks. This rotation can be captured by dividing the price of XLY by the price of XLP. You will see a rise and fall in the ratio which reflects a transition from the discretionary to staples and back.

As you can see from the chart of XLY/XLP below, the ratio has pivoted recently close to tops and bottoms in the market.

Increase in Customer Margin

In January 2023, along with the market recovery rally, we witnessed the largest month over month increase in customer margin since the peak in late 2021. This is additional risk-seeking behavior that if maintained, will support a continued rally in stocks.

Stocks Which Would Benefit from a Broad Recovery

Given these factors, blue chip companies that transport goods and make the infrastructure that supports the economy should be considered. Some of the names that we are following include: Illinois Tool Works ( ITW ), Caterpillar ( CAT ), United Parcel Service ( UPS ) and Union Pacific Railroad ( UNP ). These companies over the past three years have kept up with or exceeded the S&P 500.

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