Cyclicals or Defensives … Or Both?

A soft-landing economy could be a recipe for "both" to outperform

Usually, the relative price of cyclical stocks (those most sensitive to economic growth) and the relative price of defensive stocks (those which normally hold up the best in bear markets) tend to be inversely correlated.  When cyclicals do well, defensives underperform and vice versa.   Consequently, portfolios rarely have an overweight or underweight in both at the same time.  However, for only the second time since 1990, “both” cyclical sectors and defensive sectors have simultaneously underperformed during the last year, and both look remarkably cheap. 

Moreover, if the forecast in the coming year was for a substantial acceleration in economic growth, cyclicals would naturally be preferred, and defensives would be avoided.   Likewise, if a recession was expected, everyone would opt for defensives over cyclicals.  Today, however, while there are a variety of views on the most likely future economic outcome, the potential for a “soft-landing” is gaining favor.  Therefore, since both cyclicals and defensives have significantly underperformed in the last year, both currently offer relatively attractive valuations, and the pace of economic growth is not likely to either recess nor grow very fast, perhaps investors should consider a rather odd positioning – simultaneously overweighting both cyclicals and defensives!