3. Current Relative Risk Levels. Although cyclical sectors have always been, and probably always will be, more risky (as measured by realized volatility) than defensive sectors, there are fluctuations in cyclical sectors’ riskiness relative to their defensive counterparts. Currently this relative risk is low when compared with its average level over the last five years. This is partly because defensive sectors have become riskier as investors have flocked to them. As more crowded trades, defensive sectors are potentially more sensitive to investor sentiment and could experience greater price volatility.
However, not all cyclical sectors are created equal. Here’s a ranking of how I believe the various cyclical sectors stack up, from the most attractive to the most expensive.
- Energy (most attractive)
- Information Technology
- Industrials
- Consumer Discretionary
- Financials
- Materials (least attractive)
The list above is based on my team’s analysis of whether sector valuations appropriately price in each sector’s expected earnings growth, profitability and risk.
Based on these factors, I have a preference for the energy and informational technology sectors, accessible through the iShares S&P Global Energy Sector Fund (IXC) and the iShares S&P Global Technology Sector Fund (IXN). And as I write in my new Investment Directions commentary piece, if it turns out that we do see more investors rotating out of defensives and into more attractively priced cyclicals, these two sectors are poised to especially benefit.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.
The author is long IXC.