Cyclicals vs Defensives

We build a four-stage business cycle framework based on economic growth and capacity utilization, and then analyze historical returns for most major asset allocation decisions for each stage. Given that we are in the early recession stage (negative growth coupled and an overheated economy), our framework recommends a defensive positioning across all asset classes.

In this Strategy Outlook, we present the major investment themes and views we see playing out for the rest of 2023 and beyond.

Investors are still cautious and have significant cash that needs to be put to work. Trickle-down of it into the US equity market may extend the rally. Overly bearish futures positioning is also a strong contrarian indicator. Disinflation is good for real earnings growth, and imminent earnings rebound may add support for equities.

The S&P 500 performance was flat in May if not for the strong performance of a small cohort of mega-caps, aided by exposure to AI. Earnings and sales growth are contracting but analysts expect a rebound into a yearend, which is already priced in. Yet, inflation is still elevated, and the job market is stubbornly tight – rates will stay much higher for longer, eventually ending the party. Until then, the lopsided equity rally may continue.