Macro

Cyclical Stocks Outshine Defensives Amid Economic Boom

Cyclical sectors outperform tech with strong economic growth, as investor optimism hits new highs amid mixed consumer spending trends.

By Athena Xu

4/4, 07:39 EDT
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Key Takeaway

  • Cyclical sectors outperforming defensive stocks for four quarters, driven by postpandemic spending and high valuations in consumer-discretionary.
  • U.S. cyclical industries show high price/earnings ratios, reflecting investor optimism about avoiding a recession.
  • Historical data suggests defensive stocks may offer better long-term returns with less volatility compared to cyclical ones in today's pricey market.

Cyclical Sectors Surge Amid Economic Optimism

Despite the spotlight often shining on technology giants, cyclical sectors such as banks and industrial companies have experienced a significant rally, outpacing even the tech sector in performance this year. This rally is attributed to strong economic growth and high interest rates, which particularly benefit these sectors. However, it's noteworthy that real estate remains sluggish, and within the consumer discretionary sector, performance is mixed. The MSCI World index data reveals that cyclical sectors have outperformed defensive stocks for four consecutive quarters, driven not only by post-pandemic spending but also by rising share prices relative to earnings. In the U.S., cyclical industries now boast some of the highest price/earnings ratios relative to historical averages, indicating stretched valuations.

Investor Sentiment Hits Bullish Highs

The American Association of Individual Investors’ weekly survey shows members at their most bullish since the 2021 meme-stock craze, reflecting optimism about avoiding a recession—a scenario deemed unlikely just six months ago. This bullish sentiment, however, raises concerns about the potential overvaluation of cyclical stocks. Historical data from economist Kenneth French suggests that a portfolio balanced with defensive sectors like staples, healthcare, and utilities has historically been less volatile and offered comparable long-term returns to more cyclical investments. This data challenges the current market trend where cyclical sectors are favored despite their high valuations.

Market Momentum and Consumer Spending Trends

The S&P 500's best first quarter since 2019, driven by resilient corporate profits and AI enthusiasm, underscores the market's strong momentum. This rally isn't limited to tech giants; it's broad-based across sectors, with the Russell 2000 and value stocks also posting gains. The economy's resilience, marked by robust consumer spending and low unemployment, fuels investor optimism. However, recalibrated expectations for Federal Reserve rate cuts and rising Treasury yields suggest a more cautious outlook. Meanwhile, consumer behavior, characterized by "revenge" and "doom" spending, indicates a willingness to maintain lifestyles despite economic uncertainties, with spending on experiences like travel and dining out remaining strong.