Overall, was an incredibly challenging year. Surprisingly, cyclical stocks performed better than defensive stocks even against the backdrop of a global pandemic and economic recession. As we consider the market environment in , we have a new administration in the White House, ramped-up COVID vaccine distribution, additional fiscal stimulus, and pent-up demand for travel and leisure. However, at the same time we are seeing downward revisions to GDP growth forecasts, a slowing job market, and weak consumer spending.
This may be because was anything but normal but may also indicate a larger shift to markets. Post Comment. In this role, he is responsible for implementing and supporting Analytics clients, specifically in the portfolio analysis and quantitative space. Becker earned a B. How successful would a mean-reversion investment By Robert Zielinski Companies and Markets. Read more. But this is just one factor in building a defensive sector fund. When they suspect the economy is headed for a decline, many investors begin to pad their portfolios with defensive sector funds.
These funds are referred to as "defensive" because they tend to maintain their earnings and profits during market downturns.
This allows them to perform better than the broader market during a market correction or during a bear market. When you invest in defensive sector funds, your main goal is to defend against major decreases in share prices that might occur during these events. For instance, during tough times, consumers will reduce spending on luxury items, such as entertainment, travel, and high-end clothing, and buy only the things they need, like food, health care services, and basic utilities.
If you buy defensive stock funds that invest in industries like these, your holdings should, in theory, decline less than others. The assets that make up your fund are stocks that should remain mostly steady in price during a market decline. While defensive sectors remain mostly stable in price throughout the economic cycle, the trade-off is that they offer less drastic growth during market upswings, as compared to higher-risk, cyclical industries. These funds invest in industries that include:.
During the Great Recession, the value of gold rose dramatically. The Producer Price Index for gold increased by You can purchase defensive sector mutual funds or ETFs through a brokerage or investment firm. But before you bring these funds into your portfolio, figure out your asset allocation , or how your money will fall into different asset classes like stocks and bonds.
Then, set up the portion of your portfolio that each asset class should represent so that your choice of stock does not overweight the overall scheme. When picking mutual funds or ETFs for your portfolio, strive for diversification in your choice of stocks from the sectors and sub-sectors.
For instance, health care is a defensive sector. But if you invest all your money in it, your portfolio value will move up and down with price swings in that sector alone; no other sector would act as a hedge against losses in that sector. By contrast, if you spread your money between funds in the health care, consumer staples, utilities, and telecommunications sectors, this can provide greater diversification.
Moreover, a glance at the underlying data highlights the risk of expecting industries to comport with economic theory. We can extend this research back to the early sixties with a slightly different data set and find that utilities do indeed outperform the market in some recessions, but underperforms in others. Of course, much of this reinforces what common sense tells us: stocks are not billiard balls which will always behave the same given the same force and angle of the shot. This emphasizes the first rule of portfolio construction: diversification.
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However, a mix of both is usually wise. By developing an investment strategy that includes a healthy balance of both defensive and cyclical stocks in your portfolio, you're able to shield against total loss during a downtown and make the most of periods of economic growth.
These are the traditional defensive sectors. But it's possible for a company that's not necessarily in a "recession-proof" industry to still have stock that's considered defensive because of the company's size, history, and proven ability to adapt to changes in the market. For example, some investors might argue that certain giants in the tech sector — like Amazon and Alphabet Google's parent company — are prosperous, life- and industry-dominant, and adaptable enough to be considered defensive stocks.
At the same time, just because a stock is in a defensive sector doesn't necessarily make it a defensive stock. It still has to meet some of the other guidelines mentioned above, such as consistently paying out dividends for a long period of time and having an established, sound financial track record. Defensive stocks are also sometimes referred to as non-cyclical stocks because they don't follow the cycles of the economy.
In fact, they typically underperform when the market is up. Cyclical stocks, on the other hand, are stocks that tend to do well when the economy is doing well. Think luxury goods and services. Of course, these are also the areas that people tend to decline during harsh economic times — the automotive, travel, and high-end retail industries are a few examples. Some of the difference between the way defensive and cyclical stocks perform has to do with the industries they're in.
Being in "recession-proof" industries such as utilities, healthcare, and consumer staples helps defensive stocks weather the ups and downs of the business cycle and makes them less volatile.
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