U.S. equity sector performance suggests that a re-pricing of Fed expectations is slowly developing.
In the current cycle of Fed unorthodoxy, QE programs represent the most relevant/appropriate monetary policy tool to make historical comparisons with interest rate shifts, given that short-term interest rates are likely to stay unchanged for some time. Since the Fed began floating trial balloons last month about tapering its current QE program, cyclical sectors have outperformed while defensive and interest rate sensitive sectors have lagged. That is consistent with historical patterns leading up to Fed interest rate hikes, i.e. a change in Fed policy. Deep cyclical sectors have consistently outperformed the broad market in the six months leading up to an initial Fed interest rate hike. Defensive and interest rate sensitive sectors have underperformed.
We expect the financial sector to prove a positive exception this cycle, given that a transition to a self-reinforcing economic recovery and a subsequent alteration of the Fed’s asset purchase program should be associated with a steepening yield curve. Deep cyclical sectors should mirror historical patterns however, especially given the current valuation discount and the overwhelmingly bullish message from our Cyclical Macro Indicators.