We spend a lot of time monitoring relative sector trends, since sector rotation is a big part of our investment strategy. One of the things we’ve been noticing lately is that traditionally defensive sectors like Consumer Staples and Health Care have really started to outperform. Back in February and March when the S&P 500 declined by -6.5%, it made perfect sense to us when defensives relatively outperformed by declining less than some of the high-flying cyclical sectors. What’s been particularly notable recently is that they’re also now outperforming to the upside during this latest bounce since mid-March.
Defensive sector outperformance could mean a couple of different things. It could be a troubling indication that investors are starting to prepare for a larger downturn, possibly even the imminent desmise of the current bull market, and are taking profits in their cyclical holdings and rotating to defensives to ride out expected market volatility. Or, it could mean that the bull market is just entering a more mature phase where leadership is being passed along to the higher quality stocks that happen to be members of defensive sectors, which would be a less ominous scenario for the market as a whole.
Currently, we have what we believe is a healthy balance between select cyclical sectors that we feel are still well positioned for the time being, coupled with a material allocation to attractively valued defensive sectors. We’ll continue to keep a close on relative trends, and won't hesitate to make adjustments if we believe the market is undergoing some sort of larger transition.
