Time for a Comeback in Cyclical Stocks?

There has been a run-up recently in defensive stocks — those in sectors less sensitive to economic growth, such as utilities and health care — reports Jeffrey Kleintop, chief market strategist for LPL Financial (LPLA). But a new group of equities may be on the verge of an uptick.

“We may soon be nearing a meaningful and durable shift in the market favoring the more economically sensitive sectors that we call ‘cyclicals,’ which include industrials, consumer discretionary, materials and technology,” Kleintop said in a report released Monday.

The possible shift has to do with changes in the Citigroup Economic Surprise Index, which tracks how global data compare to expectations. The index goes up when economic data come in better than economists’ estimates and drops when it is worse.

This index has been falling in recent months, according to Kleintop, partly due to extreme weather conditions in the United States that have contributed to disappointing economic data. Generally speaking, when economic data are weaker than expected, investors tend to favor defensive stocks, which are more insulated from the slower pace of economic activity, he says. When data exceed expectations, they swing the other way and favor cyclicals.

“The very tight relationship between economic surprises and the performance of cyclicals suggests cyclicals may soon make a comeback relative to more defensive sectors,” explained Kleintop. “If the disappointing economic data reported in the first quarter turn out to have been largely the result of extreme weather, as we believe them to be, then the economic readings may begin to surprise to the upside, taking the relative performance of cyclical stocks higher along with it.” In the past, these “snapbacks” for cyclical equities have been “quick and powerful,” he adds.