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Dividend Stocks to Lag, Cyclicals to Lead: Analysts

Investors are rotating from defensive, dividend paying stocks to cyclical names as the market continues to move higher and the economy improves, two analysts told CNBC on Thursday.

"I think that we've seen the pattern start six weeks ago. It's been all cyclicals," said Scott Wren, senior equity analyst at Wells Fargo. "That was after a good run from the defensives. I think that's over. I think the pattern for the next 18-24 months is going to be very cyclical for the market."

For defensive stocks, Wren added in a "Squawk on the Street" interview, "the valuations are stretched here and the S&P 500 is likely to end a little bit lower this year. So, you could see some capital losses there."

Wren said his firm is advising clients who are overweight in health care, staples and utilities to rebalance their portfolios into more cyclical names. "Over the next 12 months you'll see those defensives higher, but they're going to lag in a big-time way from the cyclicals."

He said he doesn't see this trend ending anytime soon. "This rotation is going to continue. We could easily see something north of 1,800 in the S&P by the end of 2014. I think that will be a cyclically led market." He warned, however, that if there is a massive selloff, defensive names will become relatively more attractive.

(Related: Here's How the Party Will End If the Fed Pulls Back)

David Katz, chief investment officer at Matrix Advisors, agrees. "Economically sensitive stocks are going to be a better place to be in the upcoming year," he said, suggesting financial, energy and industrial stocks as good buys.

However, Katz said there is "a definite place for dividend stocks in a portfolio" and some consumer staples or utilities names could be good. He suggests holding a limited number of utility or consumer staple names, as well as dividend payers that are economically sensitive, such as DuPont.

(Related: Cramer: This is the Market's 'Most Undervalued Group')

Katz also sees the likelihood of dividend increases, following the trend from earlier this year. He expects Microsoft to "raise their number significantly." He said that higher payouts will happen in sectors that are not traditional dividend payers, while areas like consumer staples and pharmaceuticals will look to increase their dividends.

"There is plenty of room for dividends to increase," he said. "You can buy some stocks that are paying 3-4 percent—some volatility but not the same as the overall market and you'll get a nice growth over the next 2-3 years."

— By CNBC's Paul Toscano. Follow him on Twitter and get the latest stories from "Squawk on the Street" @ToscanoPaul

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