Earnings Recession Puts Defensives in Focus Over Cyclicals

Data company FactSet has been warning investors about an earnings recession in the S&P 500. This recession risk could put defensive sectors in concentrated focus as opposed to the more cyclical sectors, which provides an opportunity for relative weight exchange-traded funds (ETFs).

FactSet estimated that an earnings drop of 1.9 percent would result in the second quarter of 2019. In turn, that would come after a 0.5 percent drop in the first quarter, which would mean that an official earnings session would be underway if their forecasts are correct.

It’s the primary driver for investors looking for a rate cut to help prop up the market, especially after a U.S.-China trade deal that was supposed to happen eventually fell through.

“The overall market number for EPS (earnings per share) masks a very uneven picture underneath that a number of sectors are either in an earnings recession or something close to it,” said Brad McMillan, chief investment officer for Commonwealth Financial Network. “That raises questions of the strength of the economy, whether we should be concerned about a recession if this doesn’t turn around in some way. That’s why the Fed is looking at potentially cutting rates and why people are looking for a rate cut.”

This is why McMillan looks at operating earnings as opposed to earnings per share. To McMillan, it depicts a more accurate picture on the health of the economy, and furthermore, operating earnings are actually higher quarter-to-quarter and year-over-year.

This holds true for specific sectors in particular—namely financials, healthcare and utilities.

“Healthcare is positive by 32% [year over year]and IT information technology is positive by [about]2%,” said Patrick Chovanec, chief strategist at Silvercrest Asset Management. “Behind the mildly positive index level numbers, there are only a few sectors propping that up and the rest of it is in what arguably in what could be described as an earnings recession.”

As opposed to individual exchange-traded funds (ETFs), investors can also look to play defensive sectors over cyclical sectors via relative weight ETFs.

For investors looking for continued upside in U.S. cyclical sectors over defensive sectors, the Direxion MSCI Cyclicals Over Defensives ETF (NYSEArca: RWCD) offers them the ability to benefit not only from cyclical sectors potentially performing well, but from their outperformance compared to defensive sectors.

Conversely, if investors believe that U.S. defensive sectors will outperform cyclical sectors, the Direxion MSCI Defensives Over Cyclicals ETF (NYSEArca: RWDC) provides a means to not only see defensive sectors perform well, but a way to capitalize on their outperformance compared to cyclical sectors.

For more market trends, visit ETF Trends.