Per Exhibit 1, the MSCI ACWI Utilities, Health Care and Consumer Staples indices are each besting ACWI year-to-date (through May 28, that is). Thus three of the four pure defensive sectors are leading global equities higher in 2014. While I have indicated on several occasions my (contrarian) positive bias toward Utilities for 2014, and more recently, for Consumer Staples, I have observed signs in recent weeks that both areas of the market are due for an intermediate-degree breather (i.e. Investors Intelligence reported in early-May that a high number of buying climaxes had been triggered in the Utilities sector, just as weekly momentum was topping out; medium-term momentum for the Consumer Staples sector is expected to peak next week).

MSCI ACWI (USD, Gross) year-to-date performance by sector, through May 28, 2014
MSCI ACWI (USD, Gross) year-to-date performance by sector, through May 28, 2014

My expectation for a (temporary) passing of the baton by Utes and other defensives finds validation in an examination of sector-level performance for May (through the 28th). Notice in Exhibit 2 that Utilities are bringing up the rear on the basis of month-to-date performance. Consumer Staples is also lagging meaningfully. Interestingly, Information Technology and Consumer Discretionary are the only sectors demonstrating notable outperformance in May.

MSCI ACWI (USD, Gross) month-to-date performance by sector, through May 28, 2014
MSCI ACWI (USD, Gross) month-to-date performance by sector, through May 28, 2014

More evidence in support of the view that cyclicals are likely to maintain outperformer status over the medium-term comes courtesy of Exhibit 3, which shows the weekly relative performance of the Russell 3000 Dynamic Index vs the Russell 3000 Defensives Index in the top pane and momentum for the relative strength curve in the lower pane. Note that after underperforming in March and April (as is reflected by the declining curve in the top pane during this period), cyclicals mounted a turnaround in May. Bottoming weekly momentum endorses a continuation of medium-term relative strength by more economically sensitive issues.

U.S. cyclicals vs. defensives (weekly) with momentum
U.S. cyclicals vs. defensives (weekly) with momentum

Importantly though, a bigger picture outlook views the young medium-term rotation into cyclicals as a fleeting (albeit tradable) affair, as monthly momentum for my cyclicals/ defensives proxy peaked in March 2014 and looks likely to deteriorate into next year. As such, exploiting present opportunities in growth names might only be appropriate for more agile investors. Alternately stated, the current stint of cyclicals leadership looks like it will represent a last hurrah versus defensives rather than kicking off a new longer-term trend. I anticipate that defensives will reassert themselves by the late-summer/early-fall, and finish the year with superior numbers versus cyclicals.

The seemingly temporary nature of the burgeoning trend of outperformance by cyclicals is of interest for another reason as well. Per Exhibit 4, the 12-month change in the ISM PMI series (a proxy for domestic macroeconomic growth) is strongly, positively correlated to the 12-month change in cyclicals versus defensives (translation: improvement in macro activity generally coincides with cyclicals besting defensives). That my model does not expect the relative rally in cyclicals to endure supports my skepticism regarding full year growth.

Year-over-year percentage change in ISM PMI and year-over-year percentage change in cyclicals minus defensives
Year-over-year percentage change in ISM PMI and year-over-year percentage change in cyclicals minus defensives

Stay tuned!

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