The ratio in the chart above divides the MSCI USA Cyclical Sectors Index by the MSCI USA Defensive Sectors index. When the ratio rises, cyclical sectors (see next chart) are outperforming defensives - and when it falls, defensive sectors are outperforming cyclicals.
The ratio acts as a barometer of market sentiment and economic outlook. It mirrors investors' changing preferences, oscillating between seeking growth in cyclical sectors and desiring stability in defensive sectors. The ratio serves as an indicator of the economic cycle and overall market mood, suggesting a preference for either risk-taking in anticipation of growth or risk-aversion due to potential economic downturns.
The MSCI USA Cyclical Sectors index tracks the performance of the cyclical sectors within the U.S. economy. Cyclical sectors are those industries that are heavily influenced by macroeconomic changes and tend to perform well during periods of economic growth.
The index includes the following Sectors: Consumer Discretionary, Communication Services, Financials, Industrials, Information Technology, Materials & Real Estate.
The performance of these sectors is typically aligned with the business cycle, showing higher growth during economic expansions and experiencing more significant setbacks during downturns.
The MSCI USA Defensive Sectors index focuses on sectors of the U.S. economy that are generally considered less sensitive to economic cycles.
The index includes the following "defensive" Sectors: Consumer Staples, Energy, Healthcare and Utilities.
The companies from these sectors tend to offer more stable returns and are less impacted by economic downturns. Their resilience is attributed to the consistent demand for the products and services they offer, regardless of the broader economic environment. For instance, regardless of economic conditions, people still need essential goods, healthcare, and utility services.
The chart above displays the 1-year rolling correlation coefficient between the MSCI USA Cyclical Sectors and the MSCI USA Defensive Sectors indices. A correlation coefficient of +1 indicates a perfect positive correlation, meaning that the two indices moved in the same direction during the specified time window. Conversely, a correlation coefficient of -1 indicates that they moved in opposite directions.
The chart shows that most of the time, the two indices are positively correlated and move in the same direction. Since the data is available the correlation bottomed right at the start of an economic recession.
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