Just over a year ago, we called for defensives to hand over equity market leadership to cyclicals in a piece titled, Sector Rotation Playbook: Defensives Likely to Cede Leadership. As the following chart illustrates, this prognostication turned out to be a great long-term call…except that our forecast was limited to the medium term.

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Nonetheless, three months later cyclicals had bested defensives by 149 bps (as measured by the performance differential between the Russell 3000 Defensives Index and the Russell 3000 Cyclicals Index). We then advocated booking profits and setting up for defensives to reassert themselves over their economically-sensitive counterparts. Our June 2 bias in favor of defensives also added immediate value, as this cohort outperformed cyclicals by 427 bps through June 27.

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Detracting from our efforts though, we stayed too late at defensives’ party, and by the time we acknowledged the  medium and longer-term reversal back in favor of cyclicals, our June 2 call was under water to the tune of 81 bps (see our August 8 note for details).

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Nonetheless, between August 8 and the present, cyclicals have fared 510 basis points better than cyclicals on an appreciation-only basis. We see this profit as absolving us of our June misstep.

At present, our medium-term momentum work expects defensives to continue to lead global stocks, as has been the case since February 14. We note that Health Care is already the second-best performing sector of the year (we expect this group to claim the top spot before we recycle our 2017 calendars). Moreover, after severely lagging last year, the recent relative advance by the Consumer Staples sector has elevated this group to YTD outperformer status. And, on the strength of a strong showing in recent weeks, Utilities too has overtaken the broad market. Thus, of the traditionally defensive Global Industry Classification Standard sectors, only Telecom Services, the second-worst performer YTD, remains a drag on relative performance.

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Utilities and Consumer Staples appear to represent timely portfolio adds at present, as relative momentum for both sectors is expected to improve through May. Our work forecasts Utilities to outperform Staples over this horizon. Conversely, our work is most negative on Materials over the next couple of months, suggesting this segment of the equity market might represent are good source of capital for bolstering defensives exposures.

Stay tuned!!

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