Abercrombie & Fitch Stock Just Got an Upgrade to Beat Its Peers

New trends are developing in the United States stock market, which will soon attract professional investors – and traders – into consumer discretionary stocks. These stocks are characterized by their high exposure to the underlying business and economic cycle. For specific reasons that you'll learn in just a bit, there will be a coming inflow of investment dollars into these stocks.

Because of these capital rotations, you will learn that – unsurprisingly – Wall Street analysts have chosen to upgrade price targets on stocks like Abercrombie & Fitch (NYSE: ANF) on the back of a bullish thesis for the apparel and retail industry. You can follow the same "top-down" process that professional traders employ when looking for places to put their capital to work. This involves drilling down from the whole economy into specific sector dynamics.

Before you dig in, remember that you will have to understand why analysts are boosting their views on Abercrombie & Fitch stock versus other worthy mentions in the industry. These include names like American Eagle Outfitters (NYSE: AEO) and GAP (NYSE: GPS). Here's a spoiler: Abercrombie & Fitch comes out to be head and shoulders above its competition.

A New Playing Field

The Consumer Discretionary Select Sector SPDR Fund (NYSE: XLY) has underperformed the broader S&P 500 index over the past six months. However, the picture changes when you zoom into the past five days.

On a six-month basis, the consumer sector fell behind by as much as 5% and outperformed the market by the same amount in the past week. Why did the sentiment suddenly change to favor the consumer sector? It is actually a lot simpler than you think.

One of the main leading indicators that professionals follow in coming up with their trading and investment ideas is the ISM manufacturing PMI index, where you can find that the apparel industry has been recently making breakouts in business activity, a signal that the big players always pay attention to for potential opportunities.

After contracting during November and December, the apparel industry suddenly showed a breakout into expansion, which has also shown aggressive acceleration from December up to the present. There are reasons to believe that this trend is not a fluke but a sign of a significant rotation.

The market expects that the cyclical sectors (like consumer discretionary stocks) will outperform the market in the coming quarters; why? Traders believe that the Federal Reserve (the Fed) will be cutting interest rates by May 2024. You can see this expectation live by following the FedWatch tool available at the CME Group Inc. (NASDAQ: CME).

Because lower interest rates make money cheaper and make consumer financing more flexible and available, the apparel industry is showing signs of expansion in production and inventory levels in preparation for heightened demand on these new financing and purchase trends.

Here's the Target

Of course, business activity is one of many things that professionals look at. If you follow the trends in employment, the employment situation report shows that the clothing and department store industries added a combined 18,800 jobs in the past month, a period where the overall economy created 353,000 jobs.

Representing a significant 5% of total jobs added, you can probably see that hiring managers are going on hiring sprees in expectation for this same demand coming up in the following quarters, a wave that you can catch – early – today in Abercrombie & Fitch stock.

Combining all that you know now, it should be no surprise to learn that analysts at the Telsey Advisory Group have upgraded their price targets on the stock, reflecting a valuation of $140 a share, implying an upside of roughly 3% from where the stock trades today.

But Telsey is not alone; analysts at the UBS Group (NYSE: UBS) and Citigroup (NYSE: C) have also upped their price targets to levels that have proven to be conservative today, making them ripe for another boost coming up sooner rather than later.

One last check for market favoritism comes from traditional valuation metrics such as the price-to-earnings ratio. By trading at a P/E of 21x, Abercrombie & Fitch sits above GAP's 17x valuation and American Eagle's 16x. Additionally, Abercrombie & Fitch trades at a 36% premium to the sector's 16x average P/E valuation.

Remember the saying "It must be expensive for a reason" because it applies here; you now know why analysts are bullish on ANF stock. Happy surfing on the bull wave.