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Talley Léger | July 15, 2021

Is the bulk of cyclical outperformance behind us?

Cyclical stocks have surged off their early-2020 lows, but Talley Leger believes there’s still room to run. Learn more about his outlook for cyclical stocks.

As I expected, the economy-sensitive segments of the stock market have enjoyed an impressive run since their early-2020 lows.1 Now, investors are naturally wondering whether the bulk of the pro-cyclical advance is behind them.

Granted, government bond yields have softened on the back of a China-led early-to-mid cycle slowdown (Figure 1).2 Admittedly, those dynamics could challenge my bullish “reflation” thesis but ultimately may present another attractive entry point for cyclicals, in my view.

Figure 1: A China slowdown could challenge cyclical leadership but ultimately present another attractive entry point

Sources: Bloomberg L.P., Invesco as of May 31, 2021. China’s Li Kequiang Index is weighted average of the annual growth rates of outstanding bank loans (40%), electricity production (40%), and rail freight volume (20%). Shaded areas denote China all-industry contractions as defined by Caixin/IHS Markit China Composite Purchasing Managers Index (PMI) readings below 50% for three months or more. Gross domestic product is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time. Past performance does not guarantee future results. An investment cannot be made directly into an index.

True, we’ve had business cycle compression, meaning much activity and wealth has been lost and regained in a short period of time. But even if the riskier sectors outperform for half as long (three years) as the historical norm (six years), they should still have plenty of room to run. As such, I remain in the buy-the-dips camp.

Within cyclicals, the growth style of investing and technology stocks seem to be benefiting tactically from the very same China-related easing of bond yields. Beyond that, I believe there’s a window of opportunity for the value style of investing, but I’ve always considered it as a finite “recovery” trade. Ultimately, I think growth stocks should regain durable leadership as economic gravity sets in and the world settles back into a more sustainable pace of output.

Sine wave analysis helps inform the cyclical outlook

Markets don’t move in straight lines. Indeed, they undulate in complex tactical, cyclical, and secular patterns. In fact, cyclicals’ relative returns behave and look a lot like sine waves — geometric waveforms that oscillate above and below zero (Figure 2).

Figure 2: Sine wave analysis suggests decelerating but positive returns on cyclicals in the year ahead

Sources: Bloomberg L.P., Standard & Poor’s, Invesco as of June 30, 2021. The Institute for Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) is a direct measure of expectations captured by business surveys of production and the general economic climate. Diffusion indices have the properties of leading indicators, and are convenient summary measures showing the prevailing direction and scope of change. When the light blue line has risen in the northern hemisphere, cyclicals have outperformed defensives at a faster pace. When the light blue line has fallen in the northern hemisphere, cyclicals have outperformed at a slower pace. Underperformance occurs in the southern hemisphere. Cyclical returns are calculated from the S&P 500 Consumer Discretionary, Energy, Financials, Industrials, Information Technology, and Materials sector indices. Defensive returns are calculated from the S&P 500 Consumer Staples, Health Care, Telecommunication Services, and Utilities sector indices. Past performance does not guarantee future results. An investment cannot be made directly into an index.

From my lens, it took us about a year to complete the first quarter (25%) of one sine wave. In the second quarter (or next 25%) of the same wave, I think we should see decelerating but positive returns on cyclicals over the coming 12 months (Figure 3).

More importantly, there appear to have been two to three of these sine waves over the course of a given business cycle, bookended by two economic recessions. If that’s right, I don’t think investors can easily conclude that the bulk of the move in cyclicals is behind them.

Figure 3: I expect cyclicals to remain in the “positive half cycle” of the current sine wave

Amplitude is the maximum departure of the value of an alternating current or wave from the average value. For illustrative purposes only.

The bottom line: I foresee plenty of room to run

In short, China was the first out of the gate and is digesting those gains before the next potential leg higher. The U.S. was next and may also require a healthy consolidation phase at some point.

From a policy perspective, I believe something devasting would have to happen in either of the two biggest economies of the world in order to end the global expansion prematurely. In the absence of such a major policy error, I think there’s time left on the clock for economy-sensitive, pro-cyclical, risk-on trades to keep working. Stay buckled in and enjoy the ride.

1 Sources: Bloomberg L.P., Standard & Poor’s, Invesco, March 31, 2020 through June 30, 2021. Cyclical returns are calculated from the S&P 500 Consumer Discretionary, Energy, Financials, Industrials, Information Technology, and Materials sector indices. Defensive returns are calculated from the S&P 500 Consumer Staples, Health Care, Telecommunication Services, and Utilities sector indices. Past performance does not guarantee future results.  An investment cannot be made directly into an index.


2 Sources: Bloomberg L.P., Invesco as of June 30, 2021



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Header image: Jose A. Bernat Bacete / Getty

Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the simplified prospectus before investing. Copies are available from your advisor or from Invesco Canada Ltd.

Some references are U.S. centric and may not apply to Canada

Sine wave analysis measures whether a market is trending or in a cycle mode.

A cyclical stock is an equity security whose price is affected by ups and downs in the overall economy.

A defensive stock is an equity security whose price isn’t highly correlated with the larger economic cycle.

Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.

A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The opinions referenced above are those of the authors as of July 15, 2021. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.