The More Things Change, the More They Stay the Same
John McClenahan, CPA, CFA
September 2, 2014
Back in the beginning of April, I wrote a post about how the stock market can be divided into four areas of economic sensitivity:
- Defensive stocks: Stocks that perform well when investors become especially concerned about the economy. These tend to be in the consumer staples, health care, telecommunications, and utilities sectors.
- Late-stage cyclical stocks: Stocks that perform well after the economy has been growing strongly for several years and decelerating. These tend to be in the consumer staples, energy, materials, telecommunications, and utilities sectors.
- Early-stage cyclical stocks: Stocks that perform well when the economy is starting to accelerate. These tend to be in the consumer discretionary, financials, industrials, and technology sectors.
- Secular growth stocks: Stocks that perform the best when the economy is growing at a steady pace but neither accelerating nor decelerating. These tend to be in the consumer discretionary and technology sectors.
At the time of this earlier post, defensive had taken the lead as investors responded to Janet Yellen’s interest rate comments. What happened to these four areas since then? Well, first there was more backtracking on Yellen’s “six months after QE” line, and then there was bad 1Q economic data, with GDP growth coming in at -2.9%, versus an estimate of -1.8%.
People started thinking: When will this end? Could all of this economic decline be due to weather? As you would expect, late-stage cyclicals and defensives led the market.
Then in July, 2Q advance GDP growth was released at 4.0%, versus an estimate of 3.0%, and 1Q GDP contraction was revised upward to -2.1% from -2.9%. The market initially declined as these revisions raised fears that the Fed would raise rates sooner than expected. But once Yellen showed she was still dovish at Jackson Hole, secular growth returned to the forefront with early cyclicals close behind.
More recently, early cyclicals outperformed even secular growth (4.9% versus 3.6% for the month of August) as investors became more acclimated to the Fed’s improved outlook. Given that 2Q GDP was revised higher to 4.2% on August 28, the trend of early cyclicals leading the market may continue for a while—especially if the August monthly payroll number (due September 5) comes in north of the 228,000 expected. And while we’re five years into a bull market, we haven’t seen a lasting decelerating trend in GDP or rising inflation—two signs of the late stage of the economic cycle. Until we see that happening, I don’t expect a sustained shift away from early cyclicals and secular growth. Plus, there’s room for these areas to play “catch up,” given that defensives still lead year to date, thanks to their strength in the first half of the year and spikes of geopolitical uncertainty tied to Ukraine and the Middle East.
Figure 1. Defensives Still Lead YTD, Secular Growth and Early Cyclicals Make Back Significant Ground
Past performance is no guarantee of future results.
Sources: Morgan Stanley, Bloomberg LP.
Figure 2. Historical Stock Performance and Economic Sensitivity
Past performance is no guarantee of future results.Sources: Morgan Stanley, Bloomberg LP. Data through 8/31/14.
There’s growing consensus that the Fed may raise rates sooner, but it’ll be because the economy is doing well. Obviously, this is all predicated on the situation in Ukraine not continuing to escalate (which would likely lead to defensives holding up better than the other three areas).
Next up: Payrolls on September 5 and the FOMC announcement on September 17. Stay tuned. Expected GDP growth for 2015 hasn’t moved from 3.0% since mid-June.
The information in this report should not be considered a recommendation to purchase or sell any particular security. The views and strategies described may not be suitable for all investors.
The price of equity securities may rise or fall because of changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general (or in particular, the prices of the types of securities in which a fund invests) may decline over short or extended periods of time.
Dovish refers to economic policy that supports low interest rates to keep inflation in check.