This is why you should turn defensive, underweight cyclicals – UBS
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UBS analysts are underweight cyclical stocks and recommend investors to focus on growth defensives.
“Cyclicals are pricing in very high PMIs, and on P/E and P/B relative to defensives are close to historical highs,” said Andrew Garthwaite, chief global equity strategist at UBS, in a note.
He said that the cyclical good news – the Federal Reserve’s cutting cycle, fiscal policies in China, etc. – are already priced in and shared several concerns about giving preference to cyclical stocks over defensives.
First, cyclical margins in many sectors are at historical highs. In addition, the market is implying that the profit margins of cyclicals vs. defensives are going to stay at “abnormally high” levels, he said.
“Cyclicals appear to be discounting a very sharp rise in both global and European PMIs, yet UBS forecasts global growth to slow (from 3.2% in 2024 to 3% in 2025 and 2.7% in 2026) and U.S. growth to slow (from 2.7% year-over-year in the third quarter to 1.7% year-over-year in next year’s third quarter).”
Also, global earnings revisions are still being revised down, “and 65% of the time that is bad for cyclicals,” said Garthwaite.
Moreover, a short end led yield curve steepening and a soft landing would be supportive of defensives, including sectors such as pharmaceuticals (XPH), software (XSW), telecoms (XTL), and household products (SP500-3030).
Garthwaite also said that the best time to buy cyclicals has historically been when intra-index volatility is very high, since cyclicals underperform 83% when that happens, or when they are oversold.
He highlighted defensives with a growth angle: Mitsubishi Heavy Industries (OTCPK:MHVYF), BAE Systems (OTCPK:BAESF); also flavoring companies like Symrise (OTCPK:SYIEF), DSM-Firmenich (OTCQX:DSMFF); medical technology companies such as Abbott Labs (ABT), Alcon (ALC); transmission and distribution utilities such as E.ON (OTCPK:EONGY), National Grid (NGG), PG&E (PCG), Sempra (SRE); U.S. names with exposure to power price, such as Vistra (VST), Talen Energy (TLN); software names like SAP (SAP), Microsoft (MSFT); U.K. food retailing Tesco (OTCPK:TSCDF); and European telecoms like Telenor (OTCQX:TELNF).