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Market Rally Grows Legs as Breadth Improves: Stocks to Watch

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“If everyone is thinking alike, then somebody isn’t thinking.” – George S. Patton

The rally off the October lows has taken many investors by surprise. Just as the bears were ready to claim victory, the Dow surged to within 1% of its all-time high! The market’s recent breadth expansion is bullish as sectors like financials, health care, and industrials rally strongly from oversold levels. More stocks have reestablished uptrends and a healthy percentage are hitting 52-week highs.

The rebound points to a higher probability that we will ultimately eclipse the all-time highs for the major indexes in the near future. The S&P 500 is just about 4% away from its own all-time high set back in January of 2022. The previous 14 times that the blue-chip index went at least a full year without a new high and then finally made one, a year later it was higher 13/14 times and up nearly 15% on average.

Outside of large-caps, small-caps are beginning to show signs out outperformance. We’d like to see these smaller companies continue to do well, as the improvement speaks to increased odds that this rally will be sustainable. The Russell 2000 index is up about 15% from the October lows, displaying resilience as inflation and yields falter.

Cooling Inflation Trend Continues

This morning’s release of the November Consumer Price Index (CPI) showed that prices rose 3.1% over the past year, a slight deceleration from October’s 3.2% annual gain. The figure was in line with estimates, as lower energy costs held the headline figure in check. Core CPI, which strips out the more volatile food and energy components, rose at a 4% annual pace, matching the increase in October.

Tomorrow is the culmination of the FOMC two-day policy meeting, the last one of the year. Another rate pause is all but assured as markets are pricing in a roughly 99% likelihood that the Fed will stand pat. Chairman Jerome Powell stated recently that it’s “premature” to discuss rate cuts; the fact is that the economy has shown it can weather a higher interest rate environment. The central bank is looking to avoid an inflation resurgence, similar to what happened in the ‘70s.

Powell will likely leave the door open for additional rate hikes as the Fed sticks to its data-dependent path. Last week we learned that the U.S. economy added 199,000 jobs in November, ahead of the 190k estimate. The unemployment rate fell to 3.7%, reflecting signs that the labor market may not be cooling as quickly as many had anticipated. Treasury yields continue to hover near multi-month lows.

Homebuilders Break Out

Homebuilder stocks are one group outside of tech that surged this year amid low existing inventory and a declining interest rate outlook. The Zacks Building Products – Homebuilder industry has returned nearly 70% this year, handily outpacing the market:

Zacks Investment Research
Image Source: Zacks Investment Research

Despite the impressive performance, stocks in this group remain relatively undervalued:

Zacks Investment Research
Image Source: Zacks Investment Research

This industry currently ranks in the top 29% out of more than 250 Zacks Ranked Industries. Because it is ranked in the top half of all Zacks Ranked Industries, we expect this group to outperform the market over the next 3 to 6 months.

Quantitative research studies suggest that approximately half of a stock’s price appreciation is due to its industry grouping. In fact, the top 50% of Zacks Ranked Industries outperforms the bottom 50% by a factor of more than 2 to 1. By focusing on leading stocks within the top 50% of Zacks Ranked Industries, we can dramatically improve our stock-picking success.

One well-known homebuilder that has led the charge during the recent rally is Lennar (LEN - Free Report) . LEN is currently a Zacks Rank #2 (Buy). The stock has broken out and is hitting a series of 52-week highs ahead of its fiscal Q4 earnings report, slated for Thursday after the close. Lennar shares have rewarded investors this year with a 56% return:

StockCharts
Image Source: StockCharts

Analysts covering Lennar have increased their Q4 EPS estimates by 0.87% in the past 60 days. The Zacks Consensus Estimate now stands at $4.64/share, which reflects negative growth of -7.87% relative to the year-ago period. Projected revenues of $10.34 billion would mark a 1.62% improvement versus the same quarter last year.

Zacks Investment Research
Image Source: Zacks Investment Research

Another established homebuilder that has widely outperformed this year is Toll Brothers (TOL - Free Report) . TOL stock has surged nearly 90% year-to-date. Even with the impressive rebound, TOL shares are trading at just a 7.59 forward P/E. Operating on the luxury end of the market, Toll Brothers is currently a Zacks Rank #3 (Hold).

StockCharts
Image Source: StockCharts

The stock market rally has taken hold as we near the midpoint of December. The major indexes remain at year-to-date highs are tracking closer to their all-time highs; many individual stocks have broken out, while others are approaching breakout levels.

Other pockets of the market outside of tech are showing strength as the rally broadens out. Make sure you’re taking advantage of all that Zacks has to offer to uncover leading stocks like the aforementioned homebuilders.


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Toll Brothers Inc. (TOL) - free report >>

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