The value investing resurgence: favor cyclical over defensive sectors

Since just prior to the 2008 global financial crisis, we saw an extended streak of growth-oriented equities outperforming their value counterparts. Declining interest rates reinforced the notion that growth itself was in short supply—scarcity that supported a growth factor premium, particularly among the steadiest growers—but 2016 was a year of many changes.


Among them, the decade-long dominance of growth stocks began to reverse course, setting the stage for a new, procyclical market regime favoring value investing. We believe this rotation in market leadership is a technical inflection point and a technical indication of a sustainable trend that could intensify in 2017.

Procyclical leadership continues to broaden, a tailwind for value investing

As practitioners of technical analysis, monitoring market trends and shifts in relative strength provides a foundation for our investment decisions. Last year, we observed an awakening of long-dormant cyclical areas beginning to take shape—even before Donald Trump's surprise victory on Election Day. Since then, expectations of fiscal stimulus measures and reduced industry regulations have reinforced that rally, and we see value continuing to reassert factor leadership relative to growth. In our view, sectors with favorable prospects now include industrials, materials, and financials. In the months ahead, we expect procyclical leadership to broaden and consolidate further, with energy among the contenders for market leadership. Information technology represents a special case. Once the lone bright spot for cyclical exposure, the sector remains a favorite; however, as procyclical leadership continues to broaden, tech could stall in the near term while investors adjust and diversify into other cyclical sectors.

We believe defensives are done: stable growth shares take a backseat

Meanwhile, we've observed investors rotating away from the so-called low-volatility trade, and shares associated with steadier growth rates, larger capitalizations, and higher quality have seen their prices suffer. We don't expect defensive segments to reclaim market leadership in the near future: We believe defensives are done leading until we enter the next bear cycle. Consumer staples offer a case in point. An expensive sector with valuations justifiable only in the context of low and declining interest rates, consumer staples now find themselves without attractive growth or value characteristics and without an obvious marginal buyer.

While the long-running bull market for stocks remains intact, it's now supported by procyclical value equities, with low-volatility and growth factors taking a backseat as interest rates continue to rise.

Regime reversal value trumped growth as interest rates rose in 2016