Over the past few weeks, defensive sector positioning has been stunning. We just had one of the worst starts to a year in history, and while we could be due for a relief rally, we shouldn’t ignore the potential message the first five trading days of the year are sending here.
Signals are aligning and confirming we may be in the early stages of a “risk-off” set-up. Several of the risk rotation signals I’m known for have either flipped or are close to doing so.
As a rule of thumb, unanimous leadership from sectors traditionally considered safe havens during economic uncertainty – such as utilities, consumer staples, and healthcare – isn’t a good sign. If anything, their leadership tends to precede large declines.
Why Defensive Stocks Are Hot in 2024
Cyclical sectors like industrials and materials, which showed robust performance at the end of 2023, have also begun to falter. The downward turn is far from subtle, suggesting there are deeper concerns at play. There are two potential explanations for this shift:
- Overdone Rally: The rally in November and December last year might have been too optimistic, and investors could be reassessing their positions.
- Economic Data Disappointments: The significant miss on services PMI (Purchasing Managers’ Index) and services unemployment is raising alarm bells, possibly triggering a flight to safety.
On one hand, the lumber-to-gold ratio, one of the indicators which warns of changing risk conditions, has weakened notably, further confirming we may be in the early stages of a correction for broader markets. Small-caps stocks, despite nearly breaking through their 52-week highs, faced rejection, underscoring the market’s hesitancy to embrace risk.
On the other hand, gold continues to exhibit residual strength with a three-month uptrend, reaffirming its status as a refuge during times of market stress.
For investors, this shift to defensive strategies necessitates a reassessment of their portfolios. It may be time to consider reallocation toward sectors that are traditionally more resistant to economic downturns. The focus should be on companies with strong balance sheets, consistent earnings, and the ability to pay dividends. And with every day going by getting us closer to a debt refinancing tsunami, 2024 likely will be the year of quality, low beta, defensiveness, and valuation.
The Bottom Line
Bottom line here? The market’s recent pivot toward defensiveness could be a big deal, reflective of broader economic concerns and investor sentiment. While the causes are multifaceted, the confluence of an overdone rally and disappointing economic data is likely at the heart of this shift. The coming weeks and months will be crucial in determining whether this defensive posture is a harbinger of a more substantial downturn or simply a temporary retreat before the next advance.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
