Cyclicals vs defensives

We often read about ‘cyclicals versus defensives’, but what exactly does that mean? Cyclicals are companies that are sensitive to consumer and investment spending, which is often influenced by the macroeconomic cycle (hence the name). Their counterparts are defensive stocks, which are generally less affected by the stages of the economic cycle and are therefore also often referred to as non-cyclical.

Within cyclical stocks, a further distinction can be made between value cyclicals and growth cyclicals. In general, value stocks trade below their fundamental value and offer some protection against market volatility, if only because they are already trading at a discount. Growth stocks, on the other hand, are stocks that often trade at high price/earnings ratios because investors expect the companies to generate above-average profits in the future. In that sense, growth cyclicals do exhibit some sensitivity to the economic cycle, but this is within a path of structural growth.

Why do cyclical stocks look so promising?

Stock markets could not have asked for a better start to the  year. Despite a few bumps here and there, improving economic growth prospects, easing inflationary pressures, and a strong earnings season sent many markets around the world to new highs. However, the biggest question still hanging over markets is when the major central banks will start to ease monetary policy and usher in a new economic cycle. The Swiss National Bank has in fact already started its rate-cutting cycle, and we believe the rest are likely to join in by mid-2024. This should bode well for cyclical stocks, which are known for following the cycles of an economy through expansion, peak, recession.

In general, cyclical stocks tend to outperform at the start of a new cycle. However, it should be noted that equity markets typically anticipate new cycles some time in advance, and cyclicals did indeed perform well in 2023 as a strong economic recovery was priced in ahead of time. Therefore, one of the key decisions at the moment is when to add cyclical exposure to an equity portfolio.

What does this mean for investors?

While we maintain our preference for large-cap quality growth stocks for the time being, we would now start allocating fresh capital to cyclical stocks before eventually rotating more broadly into cyclicals. Investors looking to increase their cyclical exposure should be looking for names in our favourite cyclical growth segments, such as semiconductors, machinery & equipment, and transportation. Our Next Generation team has also recently upgraded the Automation & Robotics theme to Constructive, which is also a cyclical play. Finally, we see upside potential in automotives, a cyclical value segment.