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the rotation from cyclical to defensive stocks

May 2018

The case for a Swiss defence

Why Switzerland's equities could benefit if the cyclical stock rally runs out of steam

A defining feature of the stock market rally of the past two years has been the strong performance of cyclical stocks, those most sensitive to the ups and downs of the business cycle.

Since July 2016, shares of consumer discretionary, materials and IT companies have outpaced those of firms operating in traditionally defensive industries such as health care and telecommunications by 40 per cent. That’s the third widest performance gap on record. What is more, cyclical stocks are now trading at a 26 per cent premium on a cycle-adjusted basis to their defensive counterparts, a level not seen since 2010.

All this looks unsustainable at a time when global economic growth appears to be slowing. It also explains why Swiss stocks could turn out to be a bright spot in the next six months or so. Switzerland has the highest share of defensive stocks among major economies – at 60 per cent of the Swiss benchmark index’s market capitalisation. These are mainly pharmaceuticals and consumer staple businesses. Crucially, they come with attractive valuations – according to our calculations, Swiss stocks are trading at their cheapest levels relative to their global peers since 1995 (see chart).

Swiss stocks becoming cheap
Ratio of monthly total returns between MSCI Switzerland vs MSCI All-Country World in local currency (base = January 1995)

Source: Thomson Reuters Datastream, data covering period 06.01.1995 - 11.05.2018