With the broad market struggling to find a floor in the midst of a disappointing earnings season, it still pays to play defense. This week’s ISM releases reinforce that a defensive over cyclical portfolio bias is still warranted. The bottom panel of the chart shows the relative employment outlook for ISM manufacturing versus ISM services, with the pendulum swinging in favor of services industries. This relative employment ratio heralds more pain for cyclical vs. defensive equities, as most defensive sectors are services-oriented while deep cyclicals are manufacturing-intensive. Meanwhile, the bond market continues to flag elevated financial stress. Cyclical junk bond yields have been shooting higher, especially compared with defensive junk yields, reflecting relative deteriorating balance sheets. The implication is that relative share prices have more room to fall (top panel). Bottom Line: we continue to recommend a defensive versus deep cyclical portfolio tilt.
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