On May 29, 2014, we penned a note titled “Current Rotation Out of Defensives Equals Cyclicals Last Hurrah“. This piece indicated our view that U.S. cyclical equities were likely to best defensives over the medium-term. We cited market-level momentum as support for this perspective. That note also suggested that the anticipated relative rally in cyclicals should ultimately be sold, as a bigger picture inflection in favor of equities less levered to the growth cycle appeared to be on the horizon.
Since that point in late May (through September 3, 2014), the Russell 3000 Dynamic Index has appreciated by 5.6%, while the Russell 3000 Defensives Index advanced by 3.1%. Thus the call generated roughly 250 basis points of excess return. Today though, it looks like this trend has entirely run its course. Accordingly, we are endorsing an overweight of defensives over cyclicals. As is shown below, again, we cite momentum as a key support for our outlook.
Notice on the first chart that both our short-term and medium-term momentum measures are expected to roll over imminently. Further, monthly momentum (not pictured) is also at a plateau. We expect relative performance (across various timeframes) to inflect in favor of defensives in accordance with the ominous signals projected by our daily, weekly and monthly models.
Just below the broad market level, weekly momentum signals for individual MSCI All Country World Index sectors versus MSCI ACWI appear consistent with a pro-defensives stance. The second exhibit demonstrates that each of the four traditionally defensive sectors currently boast improving medium-term relative momentum (though momentum for Health Care vs. the broad global equities market is expected to peak early next month). Moreover, only two of the six more cyclical sectors feature favorable relative momentum conditions.
Sector-level signals from our longer lead momentum model (not shown) paint a similar picture. Momentum for Utilities vs. the market has been improving all year long and looks likely to improve into the Spring of 2015; monthly relative momentum for Consumer Staples will probably trough this month; and momentum for Telecom vs. the market is expected to turn up next month; relative momentum for Health Care appears stretched longer-term as well, however, the sector has, so far, managed to outperform despite the overbought momentum condition.
In closing, market- and sector-level momentum both hint that the outperformance of cyclical equities over defensives in 2013 and much of 2014 is on the brink of reversing. We therefore advocate overweighting the Consumer Staples, Utilities and Telecom sectors to take advantage of shifting winds in global equity markets.