A few weeks ago, I wrote in a Mitch on the Markets column that I’d been observing a notable rotation in the equity markets. I saw a significant shift away from cyclical sectors and towards defensive sectors. I noted in the column that in Q3 2019, the traditionally defensive Utilities and Consumer Staples sectors had been outperforming Information Technology by a ratio of at least 2-to-1, and that there were nearly 2.5 times the amount of put options on the S&P 500 Index as there were call options.

It was clearly a signal, in my view, that investors were worried about economic and equity market performance going forward, and that they were hedging against downside risk as a result.

My conclusion in that column was that investors were overpaying for this defensive posture. I believed better-than-expected economic news could drive mean reversion in the equity markets, with cyclicals outperforming. That’s what we’ve seen so far in Q4.

Over the last month, cyclical sectors like Financials, Industrials, Information Technology, and Materials have outperformed while non-cyclical, defensive sectors like Utilities and Consumer Staples have sagged. Here is a snapshot look at performance over the last month1 for these sectors:2

  • Financials: +8.79%
  • Industrials: +8.41%
  • Information Technology: +7.36%
  • Materials: +7.33%
  • S&P 500: +5.23%
  • Consumer Staples: -0.15%
  • Utilities: -4.25%

It’s clear to see that the sectors generally labeled as defensive have gotten beaten up during the current market rally. In my view, this divergence of performance marks a clear pendulum swing back into riskier categories, which one might classify as the market environment being “risk-on” again.

There is other evidence to support this shift in investor sentiment. Two exchange-traded funds (ETFs) that brand themselves as “low volatility” – the Invesco S&P 500 Low Volatility ETF and iShares Edge MSCI Min Vol USA ETF – have experienced large outflows in November and have underperformed the S&P 500 this month. Investors seem to be fleeing the defensive, worried-about-recession trades in favor of higher risk/reward categories like cyclicals.3

The bond markets are also reflecting this potential “risk-on” shift. Over the past couple of months, the 10-year Treasury yield has rebounded to its highest level since July, which is a signal that investors have been selling bonds. As you can see in the chart below, the uptick in bond yields has corresponded fairly tightly with the Q4 market rally, which I’d take as further evidence of a rotation. 

10-Year Treasury Bond Yields Have Risen Over the Past Couple of Months


Source: Federal Reserve Bank of St. Louis4

To be fair, these are all short-term moves. As a long-term oriented investor, I do not put a whole lot of stock in month-to-month or even quarter-to-quarter changes in prices across sectors and asset classes. But it is interesting to note that the prevailing recession sentiment (and the corresponding ‘wall of worry’) has seemingly been replaced with renewed optimism for stocks and growth in the US economy.

So, what’s changed? In my view, pretty much nothing at all! The media narrative on trade has changed slightly, as hopes of “Phase 1” of a trade deal between the U.S. and China may include the reduction or elimination of some tariffs between the world’s two largest economies. Time will tell.

The other, less frequently cited reason for renewed optimism and support for stock prices comes in the form of better-than-expected earnings results from Q3, in my view. To me, this offers a better explanation for why stocks have performed well recently. Total earnings (or aggregate net income) for the 469 S&P 500 companies that have reported results as of November 20 are down -1.2% (year-over-year) on +4.3% higher revenues, but a stout 72.7% of them beat EPS estimates and 57.6% beat revenue estimates.6 The takeaway: American corporations have not fared as badly as many expected.

Bottom Line for Investors

Much of this week’s column has focused on short-term price movements in the equity markets. Regular readers of my column know that I, and by extension Zacks Investment Management, place far greater importance on longer-term trends and the value of investing in stocks for 10, 20, and 30 years – not 10, 20, and 30 days or months.

Short-term shifts in investor sentiment are interesting to observe, but I hope that readers can see the folly in attempting to toggle back and forth from “risk-on”  to “risk-off.” Doing so increases the risk of mistiming the markets, and in my view, will almost certainly compromise one’s ability to generate attractive long-term returns.


1 Fidelity, November 14, 2019. https://eresearch.fidelity.com/eresearch/markets_sectors/sectors/sectors_in_market.jhtml

2 Performance by sector from October 13, 2019 – November 13, 2019

3 The Wall Street Journal, November 11, 2019. https://www.wsj.com/articles/november-rally-weighs-on-low-volatility-funds-11573493124

4 Board of Governors of the Federal Reserve System (US), 10-Year Treasury Constant Maturity Rate [DGS10], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DGS10, November 14, 2019.

5 Zacks.com, November 20, 2019. https://www.zacks.com/commentary/629846/weak-retail-sector-earnings


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