Gavekal Capital: Analyzing the Inconvenience of Counter-cyclical Stock Leadership at New Highs

Tuesday, May 6, 2014

Analyzing the Inconvenience of Counter-cyclical Stock Leadership at New Highs

Counter-cyclical stocks (utilities, telecom, consumer staples, and health care stocks) are near the top of the leader board so far this year while the more cyclical sectors have generally lagged. This is quite a change of leadership from 2013, when it was the cyclical reflation plays that took the cake (see the table below for YTD MSCI World sector performance).

For counter-cyclicals to lead the market isn't all that rare a phenomenon (counter-cyclicals are generally more recession resistant and tend to outperform in times of market turbulence). But for counter-cyclicals to be the leaders when stock indices are making new 1-year highs is somewhat rare, and the subsequent returns are not very good. Indeed, counter-cyclicals led the market at the major market peaks of 1999-2000 and 2007 and also at intermediate peaks in 2003, 2010, 2011, 2012 and 2013. Today of course we are experiencing the same phenomenon, which if history is any guide warrants some caution.

In the chart below, we show all the periods over the last fifteen years highlighted in blue when counter-cyclical areas of the market were the leaders and the MSCI World Index was also close to a 52-week high. The chart clearly shows that putting new money to work in a blue shaded area has not been a very profitable short-term strategy. There were a few periods between 2004-2006 when this indicator gave a false signal, but this indicator has not given a false positive since 2006.