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For several weeks now, I’ve warned investors that cyclical stocks are due to underperform the broader market. My favorite cyclical gauge, the Morgan Stanley Cyclical Index (CYC), reached its peak against the S&P 500 in mid-February, but only recently has it started to lag the market badly.

To give you an example of how the market’s mood has changed, on Tuesday the S&P 500 lost just 0.04% while the CYC dropped 1.51%. Investors are clearly flocking out of cyclical names for safe shelter in defensive stocks. Don’t weep for cyclical stocks; they’ve had an amazing two-year run. If the Dow Jones had kept pace with the CYC since its March 2009 low, it would be over 25,000 today.

I strongly encourage investors to tilt their portfolios away from cyclical stocks. I think we’re in for a multi-year period of cyclical underperformance. That’s how these cycles usually work. Outside of a small number of cyclical stocks like Ford (NYSE:F), your portfolios will be best served by quality stocks in defensive sectors like healthcare and consumer staples.

Fortunately, our Buy List is already light on cyclicals and our defensive issues have been helping us outpace the market. In fact, we’ve nearly doubled the market so far this year. We’re on pace toward beating the S&P 500 for the fifth year in a row. Through Thursday, our Buy List is up 12.14% for 2011 compared with just 6.84% for the S&P 500.

Healthcare is the single-largest component of our Buy List, and it’s the top-performing market sector this year. Several of our healthcare stocks, like Abbott Labs (NYSE:ABT), Becton Dickinson (NYSE:BDX), Johnson & Johnson (NYSE:JNJ) and Medtronic (NYSE:MDT), have hit new 52-week highs in recent days, and Stryker (NYSE:SYK) looks to hit a new high any day now. Also, many of our consumer stocks look very strong: Reynolds American (NYSE:RAI) is a 21% winner on the year and Jos. A. Banks (NASDAQ:JOSB) is up over 40% for us.

I should point out that we’re starting to see some signs of the bull maturing. An obvious example is the huge post-IPO surge for LinkedIn (NYSE:LNKD). The stock soared 109% on its first day of trading, which reminds me of the kind of investor frenzy we saw during the Tech Bubble. We’re also seeing analysts on Wall Street paring back their earnings estimates for this year and next. It’s not a lot so far, but it may signal that most of the easy gains are already gone.

What I find amazing is that investors still crave short-term bond maturities. I can’t decide which is more detached from reality: Investors paying several hundred times earnings for LinkedIn, or that the yield on the two-year Treasury note is now down to just 0.55%.

There’s still plenty of good news for patient investors. Q1 earnings season was a good one for the market, although the earnings “beat rate” was down a lot from previous quarters. I was pleased to see that sales growth for the S&P 500 topped 10% for the first time in five years. There are also some positive technical signs. For example, the put-to-call ratio is at a two-month high.

After breaking 1,370 on May 2, the stock market has been in a slight down trend for most of this month. This past Tuesday, the S&P 500 dropped below 1,320 for the first time in one month. Recently, however, the bulls have started to reassert themselves. On Wednesday, the S&P 500 had its biggest rally in three weeks. The market rallied again on Thursday thanks to the jobless claims report beating expectations.

I still believe this is a market that will be friendly towards investors in high-quality stocks like our Buy List. The yield curve is very wide and that’s historically bullish for stocks. Plus, yields on many of our Buy List stocks are very competitive with what’s being offered in the bond market. Abbott Labs currently yields 3.34%, Deluxe (NYSE:DLX) yields 3.75% and Sysco (NYSE:SYY) is at 3.12%. Even a blue chip like J&J yields 3.25%.

I also wanted to comment on AFLAC (NYSE:AFL) since I’ve recommended it so highly this year. The stock got hit for a 6.31% loss on Wednesday and I want you to know exactly what’s happening. Most importantly, I still like this stock a lot and I don’t see any reason to sell.

What happened is that AFLAC held a meeting with some Wall Street analysts. Most of what they had to say was good news. The company is “de-risking” its portfolio and they reiterated their earnings guidance for this year. But what everyone focused on was Dan Amos’ comments that AFLAC will grow its earnings by 0% to 5% next year.

That’s not great news, but it’s hardly awful news. First off, 2012 is still a long way away and this forecast strikes me as overly conservative. But even if it’s not, AFLAC is still a solid company going for a very attractive price.

Let’s puts our emotions aside and look at the facts. AFLAC has already said that it expects operating earnings-per-share for this year to range between $6.09 and $6.34. Some of this will obviously depend on the exchange, and that’s been working in our favor recently.

The current yen/dollar exchange rate puts AFLAC on track to earn $6.28 per share for all of 2011. Bear in mind that this isn’t my forecast or Wall Street’s; this is coming straight from AFLAC itself, and we know its guidance has been very reliable (and usually conservative).

Thursday’s closing price is almost exactly eight times this year’s earnings estimate. Even if it shows 0% growth next, AFLAC is still a bargain. Furthermore, the shares currently yield 2.38% and AFLAC said it's aiming to raise the dividend by as much as 10% this year and next. The company has raised its dividend for the last 28 years in a row.

The other good news is that AFLAC is ditching some of its assets held in problem spots around the world like Ireland. It had already dumped much of its Greek investments. This has obviously been freaking out a lot of investors.

The bottom line is that the 2012 forecast wasn’t good news and I don’t want to pretend otherwise. But considering AFLAC’s overall high-quality, recent earnings trend, decline risk and depressed valuation, the stock is still a very compelling buy.

Disclosure: AFL, ABT, BDX, JNJ, MDT, RAI, JOSB, SYK, SYY, DLX are on my Buy List.

Source: Cyclical Impact Being Felt on Key Stocks