JP Morgan says stick with cyclical stocks

Most of the cyclical shares' run versus defensive stocks may have passed but investors should not expect a reversal of the trend, JP Morgan said.

The investment bank said it was receiving more frequent client questions about whether it was time to take profits on cyclical shares and banks and buy back some defensive stocks such as healthcare and staples as well as technology.

Cyclicals have outperformed defensive shares by almost 60% since the low and have also done better than value stocks.

As long as bond yields are moving up cyclicals should not be sold, JP Morgan said. The move up in yields has further to go as policymakers accept higher yields with the strengthening economy.

The cyclical/defensive trade also shouldn't be expected to end until PMI surveys peak and in Europe money supply suggests these should strengthen strongly, the bank said. Cyclicals' earnings momentum will accelerate over the next few quarters and should hold onto their gains as a result.

The valuation case is "much more challenging" because certain defensive shares are starting to look cheap. Flows are switching from growth to value but the long-term price of value is relatively depressed despite a strong recent run, the bank said.

"The bulk of the cyc/def move might be behind us, but we think it is premature to position for an actual reversal," JP Morgan analyst Mislav Matejka said. "For that, one needs to see peaking PMIs, weakening relative earnings and an end to rising bond yields.

"Within this, a potentially firmer USD we are looking for makes us reiterate to start fading miners. We focus our longs on banks and on the consumer reopening trade, and would potentially look for a general fading of risk-on internals stance sometime nearer Q4."