With defensive sectors like consumer staples and utilities struggling and cyclical sectors such as Technology, Consumer Discretionary, and Industrials outperforming and setting new all-time highs, the U.S. economy and financial markets may be in better shape than many are projecting.
Since cyclical and defensive sectors follow different business cycles, the discrepancies between these two sectors hint at a pivotal change in the business cycle, possibly suggesting the end of the contraction cycle and the start of a recovery or an economic expansion phase.
When consumer discretionary, industrials, materials, and other cyclical areas suddenly surge unexpectedly and dramatically outperform their defensive counterparts, it suggests a transition toward a U.S. economic recovery or expansion and a bullish stock market cycle. Since consumer spending accounts for over two-thirds of the U.S. GDP, robust consumer consumption signals a healthy economy.
It is hard to know the end of a contraction phase and the start of an expansion cycle. However, the discrepancies between cyclical and defensive sectors offer subtle clues to pivotal turns in business and stock market cycles.
A brief review Relative Rotation Graph (RRG) of the S&P 500 sector chart shows the Consumer Discretionary sector (XLY) and Technology (XLK) residing in the Leading Quadrant and Industrial (XLI) rising rapidly from the Lagging to Improving Quadrant.
It is also noteworthy to highlight the RRG study of the S&P 500 Equal Weight (RSP) chart, showing Equal Weight Technology, Equal Weight Consumer Discretionary, and Equal Weight Industrials firmly entrenched within the Leading Quadrant. Two other sectors, Equal Weight Financials, and Equal Weight Real Estate, are also rising within the Improving Quadrant.
A second study involving a scan of Large-caps (SPX), Mid-caps (MID), and Small-caps (SML) shows sixty-eight (68) stocks trading at all-time highs, including thirty-four (34) Industrials, fourteen (14) Technology, and four (4) Consumer Discretionary names. Surprisingly, half of the stocks on the list are Industrial names.
A third study involving a scan of the S&P 500 stocks trading above their 50-day and 200-day moving averages reveals a dramatic improvement from previous weeks. 288 SPX stocks are trading above their respective 50-day/200-day moving averages. Cyclicals dominate the list, including Industrial (67 names), Technology (59), and Consumer Discretionary (40).
In the two prior U.S. recessions (2001 and 2007-2009) and the subsequent bear markets in stocks (the Tech/Telecom bubble of 2000-2002 and the 2007-2009 global financial debacle), wide discrepancies developed between cyclical versus defensive sectors.
The negative divergences ultimately led to a recession. The positive divergences led to a recovery/expansion. If the positive divergences sustain, this bodes well for the start of a recovery/expansion.