Surprise: Cyclicals May Soon Come Back


April 7th Weekly Market Update

So far this year, “defensive” stocks, those that are less sensitive to economic growth, such as utilities and health care stocks, have led the markets higher. However, we may soon be nearing a meaningful and durable shift in the market favoring the more economically sensitive sectors that we call “cyclicals,” which include industrials, consumer discretionary, materials, and technology.

The Citigroup Economic Surprise Index for the 10 major world economies tracks how data are faring compared with expectations. It rises when economic data come in better than economists’ estimates and falls when it is worse. This index has been falling in recent months, due in part to extreme weather conditions in the United States contributing to disappointing economic data. Historically, when economic data are weaker than expected, investors tend to favor defensive stocks, since they are more insulated from the slower pace of economic activity, and when data exceed expectations they favor cyclicals.

 The very tight relationship between economic surprises and the performance of cyclicals suggests cyclicals may soon make a comeback relative to more defensive sectors. If the disappointing economic data reported in the first quarter turn out to have been largely the result ofextreme weather, as we believe them to be, then the economic readings may begin to surprise to the upside, taking the relative performance of cyclical stocks higher along with it. As indicated in Figure 1, such snapbacks in performance by cyclicals have been quick and powerful.

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