* Cyclicals are leading in the US, lagging in Europe. In the US, Cyclicals have outperformed Defensives by 6% over the last quarter. However, over the same period European Cyclicals have underperformed Defensives by 2%. These two relative series have tracked each other closely in recent years and hence this divergence is significant. In fact, the size of the gap between the relative performance of Cyclicals vs Defensives in the US against the same series in Europe has only been exceeded twice in the last decade (moments of extreme stress in Oct-08 and late 2011).
* Diverging monetary policy is temporarily boosting European defensives – an opportunity to sell. There has been no significant change in the growth outlook for the US or Europe recently, hence this divergence most likely reflects diverging monetary policy (cyclicals traditionally outperform defensives post the first Fed rate hike as we showed in ‘1st Fed rate hike should be good for cyclical value and bad for defensives’, 12 November). Improving fundamental trends should ultimately trump interest rate differentials (and a weaker EUR is also good for European growth), and hence we’d expect this divergence to narrow driven by a period of cyclical outperformance in Europe – this is a good opportunity to sell European defensives.