The Spotlight Blog

Sensitive Cyclicals

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What We’ve Seen

  • Thanks to renewed risk-off sentiment, cyclical sectors have underperformed defensive sectors by 3.87% over the last month causing investors to once again fear that the market’s best days are behind are it. Compounding this negative sentiment is the lack of progress on the China-U.S. trade deal and a sharp drop in interest rates that appears to be driven by fears of slowing global growth or, more likely, investor realization that growth is indeed slowing just as Manufacturing Purchasing Managers Indexes have indicated for some time.
  • On the other hand, investors may want to remember that cyclicals have returned 15.80% in 2019 and are ahead of defensives by a whopping 9.17%. More troubling for cyclicals is that this outperformance has come almost entirely from multiple expansion, as opposed to earnings growth, implying that investors may have gotten ahead of themselves in pricing in further upside for the group coming off of December’s lows.

Since The Start Of Q2 2018, Cyclical And Defensive Sectors Have Taken Different Paths

Source: MSCI, as of May 28, 2019. Market represented by the MSCI USA Index, 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.

Money In Motion

  • When it comes to ETF flows, investors have been selling out of both cyclical and defensive sectors with $2.05 billion out of cyclicals and $1.45 billion out of defensives in May as ETF investors seemingly choose not to discriminate between either group. The only sectors with inflows this month are Information Technology, Utilities and Consumer Staples, while Energy and Healthcare are the laggards with a combined $1.77 billion of outflows. This mix between outperforming and underperforming groups shows that investors have been pickier with their allocations, and may actually be looking for distinct opportunities during this recent downtrend.
  • Year-to-date outflows stand at $1.35 billion from cyclical sectors and $2.85 billion from defensive sectors. However, this pales in comparison to the $14.08 billion in outflows that cyclicals experienced in Q4 2018. Interestingly, defensives took in $2.49 billion over that same period, while outperforming Cyclicals by 5.52%. This set up makes it clear that market action and flows over the last month are unique from Q4. In other words, sentiment in Q4 was driven more by investor concerns that the Federal Reserve would too aggressively tighten monetary policy, while today it may be more related to realization that market participants need to moderate their expectations for continued one-way market action at this stage in the cycle.

Both Cyclical And Defensive Sector ETFs Are Seeing Outflows In May

Source: Bloomberg Finance, L.P., as of May 28, 2019. Data represents the monthly flows of U.S.-listed U.S. Cyclical Sector ETFs and U.S. Defensive Sector ETFs specifically targeting exposure to sectors defined by MSCI as Cyclicals and Defensives, respectively.

What’s Next?

  • While the ongoing trade tensions and the decrease in interest rates continue to dominate headlines, what may be most concerning is that inflation expectations under multiple measures continue to trend lower, boding poorly for more economically sensitive sectors that rely on a favorable economic growth picture. In fact, the more that what market participants originally viewed as heated rhetoric becomes ongoing, investors will need to recalibrate economic growth and earnings expectations downward to reflect this reality.
  • From a technical perspective, cyclicals appear to be at greater risk of further near-term retracement if a broad-market drawdown were to continue, as the group remains 2.39% above its 200-day moving average. Defensives already broke through their 200-day on May 28.
  • This week, however, cyclicals are actually holding up better than defensives, outperforming by 0.91% thanks to Utilities and Consumer Staples suffering, indicating that defensives may not be as defensive as hoped in an ongoing trade war considering that Staples have one of highest levels of foreign sales.

Cyclicals Have Much Further To Fall Than Defensives

Source: MSCI, as of May 28, 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.

Implementation Ideas

  • The Direxion MSCI Cyclicals Over Defensives ETF [RWCD] offers 150% exposure to Cyclical Sectors and negative 50% exposure to Defensive Sectors allowing investors to take advantage of a potential bounce back.
  • For investors believing that trends over the last month will continue, the Direxion MSCI Defensives Over Cyclicals ETF [RWDC] offers investors a strategy that overweights sectors, such as Health Care, Consumer Staples, Energy and Utilities.

 


Definitions

  • 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.

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