Rotation Into Defensive Sectors Underway

Since the May high, the market has begun pricing in an economic slowdown. I haven't had to pull out the sector rotation model in quite some time, but it's high time we took a look at how investors are positioning themselves.

The following sector rotation model comes courtesy Stockcharts.com which borrowed it from S&P's Sam Stovall. While it's a crude representation of how the market rotates when the economy slows, it usually serves its purpose. As the market begins anticipating an economic slowdown, the Consumer Staples, Healthcare Services and Utilities sectors should begin to outperform.

click to enlarge

And you can clearly see from the chart below that these defensive sectors have started outperforming since the recent market peak.

The question now becomes how deep and long the economic slowdown will last? If energy prices and interest rates move lower, then I think the market can hold together fairly well as it rotates from one sector to another. However, if energy prices and interest rates remain high, then the market will begin discounting share prices for a recession even more aggressively.

Editor's note: ETF coverage by "defensive" sector:
- Consumer Staples: IYK, VDC, XLP
- Healthcare: IHF, IYH, VHT, XLV
- Utilities: IDU, PUI, VPU, XLU