Cyclicals until Year-End and then Defensives?

Investment timing is always fraught with peril and is never done with absolute perfection. But a Cyclicals/Defensives tilting approach may be worthwhile?

Chart 1 overlays the relative price of a S&P 500 cyclical sector proxy (including the financials, industrials, and consumer discretionary sectors) with the relative price of a defensive sector proxy (including utilities, consumer staples, and pharmaceutical sectors).  Compared to the S&P 500 index, both cyclical and defensive stocks are currently cheap.   S&P defensive sectors are at their lowest relative price since 1990, and cyclical sectors are cheaper on a relative price basis than 84% of the time since 1990.

It's uncommon to have both cyclicals and defensives cheap at the same time.  Typically, when one is cheap the other is expensive and vice versa.   In the early-1990s, cyclicals were very cheap while defensives were quite expensive.  During much of the 2000s, by contrast, cyclicals were relatively expensive while defensives were cheap.   Then from about 2008 to 2014, defensives were again more expensive than cyclicals.  Usually, if investors are bullish on cyclicals they also are bearish on defensives, or if bullish on defensives, it generally pays to avoid cyclicals.    However, at the dotcom top in 2000, as they are today, “both” cyclicals and defensives were cheap.    Does this suggest investors should unconventionally own some of both?   Probably.   Does it imply both are likely to outperform together?   Probably not. 

During the last 8 years – since about 2017 – “both” cyclicals and defensives have chronically underperformed the S&P 500 index.   An investment strategy which simply maintained an underweighted allocation to both since 2017 would have done well.   However, since their relative performances were strongly inversely correlated since 2017, some timely investment allocation decisions between these sectors would have added to overall returns.  That is, chronically underweighting both cyclicals and defensives proved profitable in the last 8 years, but being underweight overall while correctly tilting between cyclicals and defensives would have been even more profitable.  For example, cyclicals outpaced while defensives underperformed during 2017, 2020-2021, and since 2023.  Likewise, defensives outpaced while cyclicals underperformed between 2018 to early-2020 and again in 2022.   

Since “both” cyclicals and defensives are currently cheap compared to historical norms, “both” will likely outperform during the next several years.  Maintaining a secular overweight in these two areas relative to the rest of the S&P 500 Index does hold some merit.  Moreover, since these two market segments rarely outpace at the same time, employing a timing strategy which tilts their secular overweight positions could also boost investment results.