Recycle This Cycle

I haven’t been focusing on the economic cycle vs the stock cycle as much as I should have been because energy has been weighing on the entire market.  However, this morning Merrill Lynch’s navigate-the-noise analyst, Richard Bernstein, pointed out that investors are mis-interpreting the economic cycle – he’s 100% correct in my view –   

In David Bowers’s latest Merrill Lynch Fund Manager Survey (which was released today), the data seem to indicate that the consensus is that the economy is still somewhere in the mid-cycle phase.
・ As we’ve previously pointed out, US stock market leadership so far this year has been late-cycle and defensive, and has not reflected at all a mid-cycle environment. Energy, Utilities, Health Care, and Consumer Staples are the only sectors to outperform the S&P 500 year-to-date.
・ Additionally, Fed Chairman Greenspan has mentioned the potential for an inverted yield curve, and the Fed has clearly shifted its focus from growth to inflation. Late-cycles are generally characterized by the Fed shifting focus and continuing to tighten to fight inflation despite mixed economic statistics. Sound familiar?
・ Market leadership and the Federal Reserve seem to be recognizing that the economy is in the late stages, and not in the middle of its cycle. When will investors wake up?
・ We remain overweight Utilities, Health Care, and Consumer Staples. We suggest equal-weighting the Energy sector.

This coincides with Sam Stovall’s sector rotation chart, which every investor should have committed to memory –

The market is currently discounting a recession.  Investors should be overweight consumer staples and healthcare.  In addition, the focus should start turning to finding beat up financial stocks as the markets begins anticipating the bottom of the economic cycle and the Fed stops raising rates.  Once the Fed stops raising rates Energy should go from an equal weight to an underweight.