Bank of America upgrades materials sector rating, expects profit rebound from rate cuts

Bank of America strategists are bullish on the materials sector of the US stock market, partly because they expect a rebound in corporate earnings after the Federal Reserve starts cutting interest rates in September. The bank's global research department's equity and quantitative strategists said in a report on Tuesday: "We upgrade the materials sector to 'overweight' as the Fed seems to be entering a 'profit acceleration cycle' phase of rate cuts." They also highlighted the recent stimulus package announced by the Chinese government, with the materials sector being the most correlated to the MSCI China index of the 11 sectors of the S&P 500. The Federal Reserve began cutting its benchmark interest rate last month after a series of large rate hikes to combat high inflation, which has significantly eased from its peak in 2022. "Since the Fed's rate hikes, the materials sector has seen the largest decline in earnings, indicating the largest potential upside in earnings as the Fed cuts rates and profits accelerate," the Bank of America strategists said. Their report included the chart below showing the change in past 12-month earnings for the S&P 500 and its 11 sectors relative to 2021 as of the second quarter. The Bank of America strategists also cited "decades of underinvestment in manufacturing" when overweighting the materials sector, believing areas such as mining and equipment replacement could drive higher returns. They noted that metals, mining and commodities typically get support during "traditional" capital spending cycles and "ambitious decarbonization targets." The materials sector of the S&P 500 rose 9.2% in the third quarter, outpacing the 5.5% gain of the S&P 500 during the same period, making it up 12.6% year-to-date as of the end of September. The report also noted that the S&P 500 materials sector is still trading at a discount to its historical premium. The chart below shows the sector's price-to-earnings ratio relative to the S&P 500. On Tuesday, the US stock market opened the fourth quarter, with the S&P 500 falling 0.93%, the Dow Jones Industrial Average falling 0.41% and the Nasdaq Composite, which is dominated by technology stocks, falling 1.53%. The S&P 500's materials sector fell 0.32%, while the 2.66% decline in the information technology sector weighed heavily on the US large-cap index. The report also noted that the S&P 500 materials sector is still trading at a discount to its historical premium. The chart below shows the sector's price-to-earnings ratio relative to the S&P 500. The US stock market opened the fourth quarter on Tuesday, with the S&P 500 falling 0.93%, the Dow Jones Industrial Average falling 0.41% and the Nasdaq Composite, which is dominated by technology stocks, falling 1.53%. The S&P 500's materials sector fell 0.32%, while the 2.66% decline in the information technology sector weighed heavily on the US large-cap index.