Especially in Europe, macroeconomic data are improving which also explains why in Europe a cyclical tilt worked better than in the US over the past few months.

Strong correlation between US bond yield and cyclical stocks

Cyclical stocks are taking over
Source: Thomson Reuters Datastream, ING IM (March 2015)

Strong equity market performance in first two months

The year 2015 is only two months old, but it has already offered a lot of twists and turns. Global equities are up 14% in euro terms but important shifts are going on underneath. In January, the major theme was the search for stocks with stable earnings and a predictable dividend yield. The big winners were Health Care, Telecom, Consumer Staples and Real Estate. At the same time the performance got a big boost from the weaker euro, which lost almost 7% against the dollar.

Remarkable rotation into cyclical sectors

February was again a strong month for equities. Currencies were much more stable, however, and hardly contributed to the performance in euro’s. Notably, a large sector rotation took place. Following a rise in US bond yields and more stable oil prices, the search for yield theme that was dominant in January made room for a more cyclical approach. Cyclical sectors outperformed the broader market; the best performing sectors were Technology, Consumer Discretionary and Materials. Typical bond proxies like Utilities and Real Estate lost ground.

Stabilisation in oil price and rise in US bond yields

The drivers of this rotation from defensive to cyclical sectors didn’t came out of the blue and were already present for some time: an improving macro-economic backdrop and attractive valuations for cyclical companies in an environment of improving earnings momentum.

The trigger probably was the end of the sharp sell-off in oil. For those investors looking for predictable and safe yield, this provided an alternative in high-yield bonds and emerging market debt. These asset classes were particularly hurt by the distortionary impact of the sharp oil price decline on their corporate and country fundamentals.
At the same time, inflation expectations bottomed and US government bond yields started to rise. This tempered the search for yield in equities and favoured a more cyclical approach. Indeed, there is a strong positive correlation between the level of US bond yields and the strength of cyclical sectors (see graph).