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Market Rally Faces Key Test: Stocks to Watch

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Stocks staged a dramatic reversal on Thursday, placing the bulls back in charge as chip leader Nvidia’s fourth-quarter earnings results sparked a renewed sense of optimism. Both the S&P 500 and Dow Jones Industrial Average ended the day at all-time closing highs, bolstering the case that this latest rally may still have legs. Heading into Friday’s session, the S&P 500 was up 1.63% on the week, while the Dow added 1.14%.

But it’s the Nasdaq that’s taking center stage, as the tech-heavy index came within inches of its all-time high yesterday. It remains the last of the three major U.S. indexes that has yet to surpass the significant level. Market participants will be eager to see if the Nasdaq can ultimately eclipse the threshold during Friday’s session. The index was tracking higher in early trading on Friday. 

Economic Data Sends Mixed Signals

Earlier in the week we received minutes from the Fed’s January meeting, which showed that officials remain cautious on cutting interest rates too soon.

“Most participants noted the risks of moving too quickly to ease the stance of policy,” the minutes stated. Only a few officials noted the downside risks of holding policy in a restrictive manner for too long.

Given a resilient labor market and healthy U.S. consumer, interest rates have remained stubbornly high. It seems the Fed is in no hurry to lower rates, with markets now pricing in just a 2.5% chance of a cut in March.

The rate environment has certainly complicated the picture for the housing market. Sales of previously owned homes rose in January, as slightly lower rates boosted purchases. Existing sales rose 3.1% for the month to 4 million units on a seasonally adjusted annualized basis.

Still, mortgage rates have ticked back up in recent days. The average rate for a 30-year fixed loan climbed back near 7% this week, the highest average level in nearly two months.

Image Source: YCharts

While housing activity has provided us with a mixed showing thus far in 2024, market participants are still expecting activity to pick up when rates drop. But robust economic data will likely continue to prolong that process, limiting affordability for many households.

Building Products Stocks Soar

Outside of tech, building material and product companies are one group that has been leading the charge this year. The Zacks Building Products – Retail industry group currently ranks in the top 22% out of more than 250 Zacks Ranked Industries. Because this group is ranked in the top half of all industries, we expect it to outperform the market over the next 3 to 6 months. Note the favorable valuation metrics for this industry group below:

Zacks Investment Research
Image Source: Zacks Investment Research

Historical 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.

This group has also been steadily outperforming the market over the past three months:

Zacks Investment Research
Image Source: Zacks Investment Research

Several stocks within this leading industry have been outperforming year-to-date. GMS (GMS - Free Report) , a distributor of wallboard and suspended ceiling systems, has witnessed its stock rise nearly 8% this year after soaring more than 65% last year. The company has delivering a trailing four-quarter average earnings surprise of 3.15%. A Zacks Rank #2 (Buy), GMS trades at just 10.76 times forward earnings.

Zacks Investment Research
Image Source: Zacks Investment Research

Fastenal Company (FAST - Free Report) engages in the wholesale distribution of industrial and construction supplies internationally. The company provides fasteners, bolts, nuts, screws, studs, and washers used in manufactured products and construction projects.

FAST has surpassed earnings estimates in each of the past four quarters, posting an average surprise of 2.58% over that timeframe. A Zacks Rank #2 (Buy), Fastenal has rewarded investors over the past year with a better than 40% return.

Zacks Investment Research
Image Source: Zacks Investment Research

Builders FirstSource (BLDR - Free Report) manufactures and supplies building materials and construction services to professional homebuilders, sub-contractors, remodelers, and consumers in the United States. The company also provides specialty products such as siding, exterior trim, roofing, cabinets, and insulation.

Just yesterday, BLDR delivered fourth-quarter earnings of $3.55/share, a 31.5% surprise over consensus estimates. The building materials company has posted a trailing four-quarter average earnings surprise of 40.6%.

A Zacks Rank #1 (Strong Buy), BLDR stock is ranked favorably by our Zacks Style Scores, with a top ‘A’ rating in our Value and Growth categories. Builders FirstSource stock has been on a tear this year, climbing nearly 15%.

Zacks Investment Research
Image Source: Zacks Investment Research

How to Approach This Rally

This market is showing signs of strong momentum. Leadership from the more aggressive pockets of the market (consumer discretionary, information technology, communication services) is another positive sign that points to a higher probability of more bullish outcomes moving forward.

Other pockets of the market outside of tech, such as building products stocks and homebuilders, are also showing strength.

Still, we want to always approach the market from a risk-first perspective. Many stocks are extended in the short-term, so it makes sense to be cautious here with any new additions. Scaling into long positions to mitigate timing risk is a sound strategy in this environment.

See More Zacks Research for These Tickers

Normally $25 each - click below to receive one report FREE:

Fastenal Company (FAST) - free report >>

Builders FirstSource, Inc. (BLDR) - free report >>

GMS Inc. (GMS) - free report >>

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