Market Update: Cyclical Sectors vs. Bond Proxies

Deep cyclical sectors have been battered and bruised over the past six months, as concerns about slowing economic growth negatively impacted them. In contrast, bond proxies like utilities have performed better.

This shift towards bond proxies—such as utilities, staples, and healthcare—was likely triggered by fears surrounding a stalled U.S. consumer, amplified by significant downward revisions in payrolls and disappointing corporate earnings from major retailers such as Dollar General (NYSE:DG), Target, and Starbucks (NASDAQ:SBUX). Louis-Vincent Gave of Gavekal Research noted these trends in a Wednesday report.

Economic data from China, especially in the real estate sector, also offered little cause for optimism. The recent third plenum of the Communist Party failed to introduce substantial measures aimed at boosting investor confidence, intensifying concerns regarding China’s economic trajectory.

However, there are signs of potential economic recovery that may reinvigorate inflation and investor interest in cyclical sectors. Key factors influencing this outlook include:

• Pent-up demand for hiring
• Increased capital spending
• Low energy prices
• Corporate spreads that are near record lows
• Eased monetary policies from the Federal Reserve and the People’s Bank of China

Gave pointed out that any single one of these factors could lead to reflation, but their combined effect could be significantly impactful, especially as investors have largely turned away from cyclical asset classes.