What We’ve Seen
- With a 0.86% spread, Defensive sector performance relative to Cyclical sectors on Friday, March 22, was the best single day for Defensives relative to Cyclicals since January 3. January 3 and March 22 also happen to be the worst days for the MSCI USA in 2019. Until last week’s selloff, Cyclicals have trounced Defensives by 7.10% since US markets bottomed on December 24. Much of this can be attributed to the Information Technology sector, which is up almost 28% over that time.
- Using a simple measure of “market breadth”, the percentage of members in a given basket trading above their respective 50-Day Simple Moving Averages, provides some insight to the Cyclical and Defensive Sector baskets. Not surprisingly, market breadth throughout the Defensive Sectors was notably higher than Cyclical Sectors throughout the drawdown in the fourth quarter of 2018. Since December 24, 2018, market breadth among the Cyclical Sectors rose dramatically, and have been notably higher throughout most of 2019. Over the trailing 5 days, however, this relative relationship has once again flipped towards Defensives, as over 74% of Defensive Sector names are trading above their 50-Day SMA, while only 63% of Cyclical Sector names are trading above their 50-Day SMA.
“Market Breadth” Across Cyclical Sectors & Defensive Sectors
Source: Bloomberg Finance, L.P., MSCI, as of March 26, 2019. Past performance is not indicative of future results. One cannot invest directly in an index.
Money in Motion
- While Cyclicals have outperformed sharply, ETF investors have been getting defensive with rolling 1-month flows favoring Defensive Sector ETFs relative to Cyclical ones. As the figure below shows, net flows between the groups peaked on February 28 and have been trending toward Defensives since then.
- Peeling these flows data back a layer, Technology sector flows have been especially weak, with outflows of $819 million over the last month and $2.63 billion over the trailing 3 months, highlighting how ETF investors have faded the recent rally in technology shares.
Flows into Cyclical Sector ETFs have Started to Wane
Source: Bloomberg Finance, L.P., MSCI, as of March 26, 2019. Data represents the rolling 1-month net flows of U.S.-listed U.S. Cyclical Sector ETFs relative to U.S. Defensive Sector ETFs specifically targeting exposure to sectors defined by MSCI as Cyclicals and Defensives, respectively. Past performance is not indicative of future results.
- U.S. yields, especially at the longer end of the curve, have moved dramatically lower since the fourth quarter of 2018. Since October, 2018 to calendar year end 2018, the U.S. 10-Year Treasury Yield fell from 3.084% to 2.684%. As one might expect, this drop in the 10-Year Yield was matched by the relative performance between Cyclical Sectors and Defensive Sectors, as the latter outperformed by 5.52% over the last 3 months of 2018.
- The relationship between growth expectations, as portrayed by the U.S. 10-Year Yield, and the performance of Cyclical Sectors relative to Defensive Sectors tends to be a notably positive one. However, investors should keep an eye on the divergence that has formed between the two since December 24, 2018. While the 10-Year Yield has continued to fall (from 2.738% to 2.423%), Cyclical Sectors have outperformed their Defensive counterparts by over 7%.
Cyclicals to Defensive Relative Performance has Diverged from 10-Year
Source: Bloomberg Finance, L.P., MSCI, as of March 26, 2019. Cyclicals represented by the MSCI USA Cyclical Sectors Index and Defensives represented by the MSCI USA Defensive Sectors Index. Past performance is not indicative of future results. One cannot invest directly in an index.
- If investors believe that last Friday was a sign of deeper cracks in the recovery and want to hunker down by tilting toward historically defensive sectors, the Direxion MSCI Defensives Over Cyclicals ETF [RWDC] offers them a strategy that overweights defensives relative to cyclicals.
- Conversely, if investors believe that markets will make new highs driven by pro-cyclical sectors, the Direxion MSCI Cyclicals Over Defensives ETF [RWCD] makes for an attractive allocation thanks to its tilt toward information technology and away from healthcare.
MSCI USA Cyclical Sectors Index: The MSCI USA Cyclical Sectors Index is based on MSCI USA Index, its parent index and captures large and mid-cap segments of the US market. The index is designed to reflect the performance of the opportunity set of global cyclical companies across various GICS® sectors. All constituent securities from Consumer Discretionary, Financials, Industrials, Information Technology and Materials are included in the Index.
MSCI USA Defensive Sectors Index: The MSCI USA Defensive Sectors Index is based on MSCI USA Index, its parent index and captures large and mid-cap segments of the US market. The index is designed to reflect the performance of the opportunity set of global defensive companies across various GICS® sectors. All constituent securities from Consumer Staples, Energy, Healthcare, Telecommunication Services and Utilities are included in the Index.
MSCI USA Index: The MSCI USA Index is designed to measure the performance of the large and mid cap segments of the US market.
MSCI USA Cyclical Sectors: USA Defensive Sectors 150/50 Return Spread Index: The MSCI USA Cyclical Sectors – USA Defensive Sectors 150/50 Return Spread Index measures the performance of a portfolio that has 150% long exposure to the MSCI USA Cyclical Sectors Index and 50% short exposure to the MSCI USA Defensive Sectors Index.
MSCI USA Defensive Sectors: USA Cyclical Sectors 150/50 Return Spread Index: The MSCI USA Defensive Sectors – USA Cyclical Sectors 150/50 Return Spread Index measures the performance of a portfolio that has 150% long exposure to the MSCI USA Defensive Sectors Index and 50% short exposure to the MSCI USA Cyclical Sectors Index.
Direxion Relative Weight ETF Risks: Investing involves risk including possible loss of principal. The Funds’ investments in derivatives may pose risks in addition to, and greater than, those associated with directly investing in or shorting securities or other investments. Cyclical stocks tend to rise and fall with the business cycle and are typically companies that provide consumer discretionary good or services. Defensive stocks tend to remain stable during various phases of the business cycle due to constant demand for products. Defensive stocks generally include utility and consumer staples companies that produce goods bought out of necessity. There is no guarantee that the returns on the Funds’ long or short positions will produce high, or even positive returns and a Fund could lose money if either or both of the Fund’s long and short positions produce negative returns. Please see the summary and full prospectuses for a more complete description of these and other risks of the Funds.
Distributor: Foreside Fund Services, LLC