Will Cyclical Outperformance Continue for U.S. Equities?

December 01, 2016

This week’s chart highlights recent changes in sector leadership across U.S. equities.

The first half of the year was marked by global growth concerns coupled with reduced expectations for further interest rate hikes in 2016. As this sentiment became priced into the market, a flight to perceived safety ensued which helped to fuel the strong performance of defensive sectors. Telecom, Utilities, Real Estate, and Consumer Staples were the main beneficiaries of this trend. Additionally, these sectors tend to offer attractive dividend yields. Strong interest from yield seeking investors, given the current low interest rate environment, helped propel performance and valuations to elevated levels within these sectors.

The third quarter saw signs of improved economic growth in the U.S. along with positive earnings growth for the S&P 500. The third quarter earnings growth followed five consecutive quarters of negative year-over-year growth. Cyclical sectors were the main beneficiary of these growth improvements, and this trend has continued post-election given the pro-growth rhetoric of a Trump administration and the subsequent expectation of higher interest rates in the future.

This performance leadership from cyclical sectors may continue — at least in the near-term — given the headwinds facing defensive sectors (valuations trading at premiums to the broad market and expectations for higher interest rates) as well as the tailwinds for cyclical sectors (valuation levels relative to defensive sectors and higher expected GDP growth).