With all the churning underneath the surface of the stock market lately, it is a bit difficult to separate the signal from the noise when analyzing leadership trends and asset allocation. On balance, we think the evidence still supports an overweight position in counter-cyclical stocks, but we would really focus mostly on health care and consumer staples--the growth counter-cyclicals. Looking at our equal-weighted sectors, calculated from the bottom-up, we can see that health care and consumer staples are still the number one and two on the global equity leader-board.
MSCI World Performance
Below we outline our five reasons why we think an overweight stance in counter-cyclicals still makes sense.
Reason #1: Over the last five years, cyclicals only outperform counter-cyclicals when the Federal Reserve's balance sheet is growing. Currently the three month change in fed assets is negative $30 billion.
Reason #2: The four year old USD bull market has not been incorporated fully into the relative performance of counter-cyclicals. Yes counter-cyclicals have outperformed, but they should have outperformed more.
In particular, the USD strength has not been fully factored into growth counter-cyclicals.
Reason #3: Counter-cyclicals outperform when TIPS rates are falling. TIPS are 5bps away from taking out one year lows.
Reason #4: The outperformance of MSCI World counter-cyclicals relative to cyclicals is highly correlated with the relative outperformance of the S&P 500 (total return) relative to the JPM Government Bond Index (total return). Bonds have been outperforming stocks for over a year.
Reason #5:Counter-cyclicals tend to outperform when the CRB Commodity Index underperforms the overall CPI level. In other words, when headline inflation is less than core inflation, counter-cyclicals outperform. The CRB has underperformed the CPI by 17% since May 2014.