Key signals investors may be missing

The market has continued to notch a series of new highs in the past couple of months—fueled by an expectation of further rate cuts, continued earnings strength, and growing confidence in a soft landing.

Yet to many investors these gains have seemed to fly in the face of reason, given the high degree of uncertainty posed by the upcoming election. My research focuses on analyzing market history, to uncover patterns and probabilities that can help challenge investors' biases and provide a more objective backdrop for understanding the current environment. Recently, my research has turned up important signals in interest rates and oil prices that suggest the stock market broadly could still have room to run. Historically, these signals have preceded strong performance in one sector in particular: real estate.

Here's more on 3 key themes for investors to consider now.

1. Oil and interest rates may matter more to markets than the election

To be sure, there are plenty of headwinds for the market right now, including geopolitical risk, election uncertainty, the potential for tax increases, and more. But sometimes, investors are so focused on the visible headwinds (which take up more space in the news and in our minds) that they miss a powerful tailwind.

That's exactly what I believe has been happening in recent weeks, as a major potential tailwind from oil prices and interest rates has largely gone unnoticed. Yields on 10-year Treasury bonds fell significantly during the 12 months through mid-September, as inflation declined and the market anticipated the Fed's interest-rate cut. Meanwhile, crude oil prices fell steeply over the same period, as oil supplies increased and demand weakened.

Simultaneous drops of this magnitude have been relatively rare in the past—and it's particularly rare for them to occur without significant job losses. But when they have occurred, they typically have served as a strong tailwind for stocks. After periods in which both fell 15% or more, as they did this time, the S&P 500^® has returned 18.9% on average over the next 12 months.

The historical data bears out this relationship, but it also makes intuitive sense. Falling interest rates and oil prices leave more in consumers' pockets, letting them spend more. And they leave more in company coffers, helping them deliver stronger earnings. In combination, they can provide a powerful economic stimulus.

Skeptics may point out that oil and rates have rebounded slightly since mid-September. They may also rightly ask about whether further gains are sustainable given the market's already-high valuations. In fact, it's common for both indicators to bounce back after declines of this magnitude, but the impact on stocks tends to happen with a lag, which is why I'm still bullish about the next year. As for valuations—historically, a double boost of falling rates and lower oil prices has pumped up the stock market even after it was expensive. After past times when both interest rates and oil prices fell at least 15% and the S&P 500's price-to-earnings ratio was in the top 25% of its historical range, stocks still returned 16.3% over the next 12 months, on average.

2. Cyclical sectors may receive the biggest boost

Historically, those dual tailwinds have created a strong cyclical, pro-risk impulse. The bigger the "stimulus" from rates and oil, the more likely you are to see subsequent outperformance from cyclical sectors, including technology, consumer discretionary, communication services, financials, and real estate.

An additional signal on this point has been 1-year Treasury bill yields, which also fell precipitously over the year through mid-September. In fact, the dual decline in 1-year Treasury yields and oil prices was in the top 10% of its historical range dating back to 1962.

Looking at similar past periods since 1962, cyclical sectors outperformed the broad market by 4 percentage points over the subsequent 12 months. (In recent decades the boost has often been even stronger, with cyclicals subsequently outperforming by 9 percentage points in similar periods since 2000.)

Again, the data bears this out but so does intuition. Interest rates and oil prices matter for future earnings growth. After similar combined moves since 1962, earnings have grown an average of 20% over the following year.

3. Real estate is a top sector to watch

Since 1962, real estate has gotten the greatest boost of any sector from the dual tailwind of falling rates and crude oil prices.

Again, this makes intuitive sense considering that lower interest rates and oil prices both make real estate more affordable. Falling interest rates can make home mortgages and business loans less expensive, and falling crude prices can help reduce the cost of building.

Needless to say, if some sectors outperform, others must underperform. My research suggests that in the pro-risk environments these tailwinds tend to produce, defensive sectors may lag the market. Those sectors include consumer staples, health care, and utilities—with utilities historically showing the worst performance in periods following steep declines in oil and rates. (Note that sectors can lag the market but still produce positive returns.)

In conclusion

Based on this analysis and other research, I think the current economic and market environment seems likely to support further stock-market gains. Investors looking for the most attractive opportunities may want to focus on cyclical sectors, particularly real estate.

Investors interested in exploring real estate investment opportunities can consider real estate investment trusts (REITs), which invest in real estate and trade like stocks. Fidelity customers can search for individual REITs using the Fidelity Stock ScreenerLog In Required. Or, to search for mutual funds or ETFs that focus on real estate or any of the other investment themes mentioned above, investors can use the Fidelity Mutual Fund Research tool or ETF ScreenerLog In Required.