We discuss the outlook for cyclical stocks.

  • In the near term, it may be that investors who have made significant returns in secular growth sectors like technology take some profits and allocate towards cyclical stocks, having already switched from low-growth defensives.
  • However, we do not expect technology stocks to tread water for long.
  • As 2021 progresses, there is a danger of getting overenthusiastic about cyclicals.
  • The current trend is largely based on headline valuations, and it may take some time before it is justified by earnings.

When Covid-19 and subsequent lockdowns arose, many businesses in energy, financials and industrials sectors bore the brunt of the economic freeze, owing to lack of demand and the inability to operate normally, if at all. This prompted cyclicals to sell off, as capital was reallocated to areas like technology, which showed resilience or, in some cases, stood to benefit from the resulting change in lifestyle. But after headlines began to surface on promising vaccine candidates, cyclical names started to take in money once again.

We believe other factors, beyond news of the vaccines, are at play. Crucially, the valuation discrepancy between cyclical and secular growth sectors had become startling. Furthermore, much of the world is loosening fiscal policy in addition to existing – and long-standing – loose monetary policy. As concurrent looseness of fiscal and monetary policy has tended historically to induce a reflationary environment, cyclical stocks have a better chance of outperforming in the near term. In this type of environment, these names often tend to rise along with bond yields.

As cyclical sectors continue to recover, money has been rotating out of secular growth names in defensive sectors like health care and consumer staples.Money has been flowing from health care, partially owing to politically fuelled uncertainty, and consumer staples, which could see greater divestment because such stocks do not typically boast high growth and lack comparable tailwinds to technology’s acceleration of adoption.

In the near term, it may be that investors who have made significant returns in more defensive areas and technology take some profits and allocate towards cyclical stocks. However, we do not expect technology stocks to tread water for long. We believe technology could start to outperform again, not least because the amount of corporate spending on technology shows no sign of letting up, and in fact is accelerating. So although there may be slings and arrows in the short term, we expect to see strong performance from the technology sector over a 10-year timeframe.


While technology’s success may be a long-term narrative, the current cyclical rotation is not expected to last throughout 2021. Indeed, there are likely to be headwinds for cyclical sectors once the current enthusiasm dies out.

At some point, reality will kick in and government-support programmes will be lifted. When that happens, the market might conclude that those cyclical stocks that rallied may not be rewarded with higher earnings, and investors may then run back into the arms of some of those secular growth stories.

Another headwind for some cyclical stocks could be possible irreversible effects to business operations. Psychologically, some consumers may find that they are not ready to get back on planes and return to high-touch environments. Likewise, some may decide they do not miss commuting. Just as the pandemic accelerated certain trends, it may have triggered permanent lifestyle changes. These changes could become a secular headwind to the cyclical winners of today.

Because of this, maintaining some exposure to defensive names may be warranted, particularly those companies that can participate in the cyclical rally. At this stage, within technology, hardware stocks are less expensive, and tend to be more cyclical so they can participate in these value rotations. But the basis for many of these businesses is rooted in secular growth through increased digital exposure. It is therefore possible to gain access to something of the ‘best of both worlds’ with some names in this area. Over the long term, these businesses could be more likely to be winners than some of the more traditional cyclicals which are now starting to lead the market.

There are also companies within health care, notably in the pharmaceutical industry, which have exposure to long-term growth drivers but are now priced more attractively, thanks in part to the rotation. We may continue to see some weakness in this area as the Democratic Party takes the reins of power in the US – with some near-term focus on the Senate run-off in Georgia in January – but health care remains a long-term thematic beneficiary in our view.

A balancing act

US markets tend to be technology-oriented and offer more of a growth tilt, while Europe and Japan tend to be more value-oriented. Specifically, Germany, has a lot of ‘old-school’ industrial businesses.

Looking ahead, at the margin, there could be a slight shift out of US equities and into continental Europe and Japan. And if the reflationary environment results in a weaker US dollar, the real trade to watch might be emerging markets, which could do well.


Paul Markham

Paul Markham

Head of Global Opportunities


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