If the stock rally — which has flashed signs of fatigue in recent days — is to keep chugging along, investors must elevate their risk-taking and animal spirits.
A strong defense may be key to winning an NFL title, but a defense-first game plan executed by Wall Street can act as an impediment to a bull market.
"Typically, defensive stocks fail to lead market rallies over the long term," says Gina Martin Adams, senior analyst at Wells Fargo. And this year's rally has been led largely by "defensive" names. Stodgy dividend-payers are in vogue. Telecom provider AT&T, which sports an annual yield of nearly 5%, is up 24%. Companies such as toothpaste maker Colgate-Palmolive (up 14%), which sell everyday staples consumers can't do without, are also hot. Health care stocks, another sector that does well in tough times, are thriving.
The problem? Historically, market advances with staying power have been driven by "cyclical" stocks — companies whose fortunes are more closely tied to an improving economy.
The market flirted with a new 2012 high all week but fell short. The Standard & Poor's 500 closed Friday at 1406, less than 1% shy of its April high of 1419. It's up 11.8% this year. Data out Friday showing China's economy is slowing more than expected gave investors pause. It offset the recent optimism driven by stronger U.S. job gains and the belief that U.S. and European central bankers will inject more stimulus into the economy if needed.
A return to cyclical stocks is bullish because "it tells us people expect the economy to improve," says Rich Suttmeier, a strategist at ValuEngine.com. But these "bull market" sectors, most notably industrials and materials, have lagged badly this year. Aluminum giant Alcoa is up less than 4%. U.S. Steel is down almost 12%. Aerospace giant Boeing is up 1%. Machine maker Caterpillar has lost nearly 2%.
"If you're looking for confirmation of longevity to this rally, you want to see cyclical stocks lead the way," says Sam Stovall of S&P Capital IQ. The baton handoff from defensive stocks to offensive ones may be underway. In August industrials and materials are two of the top three performing sectors.