The market has now gone through a complete cycle in record time. From 2020 to today, it seems that interest rates and the underlying business cycle have gone from one end of the spectrum to the other without causing any of the turmoil that typically comes with such a swing.
These cycle swings can be a time for you to start fishing for outsized returns. Still, you don't want to go about it blindly. So here's how the professionals tend to go about it on Wall Street. For simplicity, there are consumer staples stocks which are characterized by their relative immunity to the business cycle. Consumer discretionary stocks, in contrast, are known for their high exposure to where the cycle is or is expected to be.
Knowing what you know now, it would be unlikely that you'll choose to look into stocks like Procter & Gamble (NYSE: PG), which falls into the staples sector. People will likely keep buying their products regardless of whether it is a booming or busting recession. For this same reason, stocks like Foot Locker Inc. (NYSE: FL) become highly interesting to investors looking for value in an upcoming swing.
The Macroeconomic Breakdown is Favorable
What could make the prominent market players even look into these cyclical stocks in the first place? After all, the Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY) has underperformed the broader S&P 500 index by as much as 5% during the past six months.
However, zooming into the past five days, the consumer discretionary sector outperformed the broader market, meaning that traders and investors could already be pricing in their future expectations as to where the market could rotate in the coming months. Here's why their views are starting to change.
The Federal Reserve (the Fed) has expressed the potential for interest rate cuts coming this year. Yet, some market participants still need to be convinced about the timing of these cuts. According to the FedWatch tool at the CME Group Inc. (NASDAQ: CME), traders are now pricing these interest rate cuts as soon as May of this year.
Lower interest rates mean cheaper money in the market. You better believe that the American consumer will be first in line to take advantage of cheaper money, more flexible financing rates, and promotions from their favorite brands, such as Foot Locker.
Considering that other players in the retail space, such as Dick's Sporting Goods Inc. (NYSE: DKS), are trading at much more expensive levels relative to Foot Locker, not only on a price action basis but also on a traditional valuation basis. This is the fundamental case for investors to start a value-seeking investigation.
Beginning with price action, the overall sector trades at an average of 90% of their 52-week high prices. In contrast, Foot Locker sits at an attractive discount of 73% today. Digging into this performance gap, institutions like Charles Schwab Co. (NYSE: SCHW) and the Royal Bank of Canada (NYSE: RY) have started to buy the stock. And the bullish case for Foot Locker gets better.
Why Foot Locker?
From the price discount considered to previous levels over the past twelve months, investors will notice other valuation metrics that make Foot Locker a clear buy target. By upping their stakes by as much as 9% and 12% over the past month, institutions lead the way to show you what's next.
On a price-to-book basis, the overall industry trades at an average of 4.1x, whereas direct competitor Dick's is an overvalued name at 5.8x P/B and also trading at 99% of its 52-week high to offer no discount to its shareholders.
Foot Locker, on the other hand, trades at a 78% discount to the industry with its 0.9x P/B valuation. But that is all in the present; it gives you a leg to stand on, but if you want to run, then it is the future you must understand.
Analysts are projecting an average earnings per share growth rate of 8% over the next twelve months for the industry and a more specific 4% for Dick's. At the same time, analysts see a lot more upside in Foot Locker's financials, projecting a significantly higher EPS growth rate of 46% over the year.
Considering that EPS typically drives stock prices, you can now see why Foot Locker's discount is not pricing in the 46% growth whatsoever. In contrast, other stocks are not only already pricing in their growth but also overextending these projections.
