Right now, the market is sending mixed signals. Cyclicals have led this year as some investors bet on faster growth. Recently, defensive sectors have also come to life, which sometimes happens in the early innings of an economic soft patch. For both of these things to take place at the same time is unusual.
But it could be a mistake to treat the clash as a debate about the economy. The most useful place to start is with flows.
For years, money kept piling into hyperscalers such as Amazon, Microsoft, Meta and Alphabet. They were dominant and hard to underweight. They also generated massive cash flow, which funded buybacks and helped support their stocks when the rest of the market wobbled.
Now those companies are spending more of that cash on AI infrastructure, including data centers, chips and cloud capacity. That shift likely means lower free cash flow and fewer buybacks, which can put pressure on share prices.
That does not mean their fundamentals are suddenly weak. It just means investors may become more cautious about what they are willing to pay.
When something like this happens, the money does not disappear. It typically moves into other parts of the market, and when it does it’s rarely in a straight line.
Some of it flows to areas that have been ignored in recent years, including cyclical equity groups like financials, industrials and materials. Since the market has lacked breadth for years, even modest moves can make these groups look like winners.
Time will tell whether that holds. The larger point in the short term is that broader participation can create greater dispersion as money rotates from large-cap growth stocks to smaller-cap cyclical names. That, along with AI disruption worries in software, has contributed to more single-stock volatility, which investors may perceive as systemic risk.
That is likely what is driving the unusual pattern of cyclicals and defensives moving together. If that is the backdrop, the move into defensives may be easy to misread. Yes, it could portend that a growth slowdown is looming. But it may simply reflect investors repositioning portfolios, shifting away from the old leaders while keeping some protection in place as the market broadens out.
So where does that leave us? If investors are reducing exposure to the handful of stocks that have carried the market in recent years, cyclicals are the most straightforward place to look, especially industrial and materials companies.
Copper prices are often a useful window into how businesses are thinking. Companies ramp up building and investment only when they trust the economic outlook, and when that happens, demand for copper tends to rise. We are starting to see early signs of that pickup, which is good news for materials companies like Freeport-McMoRan and Ivanhoe Electric.
Meanwhile, industrial firms should also do well, particularly Caterpillar. The construction and engineering equipment manufacturer should benefit from the recent growth in global manufacturing activity.
There is also a second layer worth watching. As hyperscalers pack more computing power into their existing data centers this year and next, they will need more networking gear to connect it all. That should lift demand for switches, optics and related connectivity, benefiting the likes of Coherent, Amphenol and Arista Networks.
The scoreboard is simple. If breadth holds and cyclicals keep working, this is rotation plus hedging, not an economy rolling over. If defensives take over, the caution trade may be turning into something darker.
For now, though, the split in leadership looks less like a recession call and more like a market trying to move on from an old regime without fully trusting the transition
