At another point in the economic cycle – at the transition to recession – defensive sectors should actually be doing better. Since recessions are often accompanied by sharp setbacks on the stock markets and a number of cyclicals cut dividends or even cancel dividends, investors should increasingly focus on defensive sectors – so the theory goes.
Typical representatives of the defensive industry include the food sector and other producers of everyday needs, such as manufacturers of hygiene items. Unlike many long-lived and more capital-intensive consumer products, such as televisions, cars, etc., for which demand usually falls during a recession because consumers are more likely to postpone expensive purchases during economic upswings – everyday consumer products should also remain in demand during an economic downturn. In the defensive consumer sector, sales and profits are therefore unlikely to collapse much despite a recession. Despite the recession, people continue to eat and drink, smoke, shower and brush their teeth.
The question therefore arises as to whether these market logics and relationships can really be proven and whether excess returns can be achieved with the knowledge of the sector rotation.
industry rotation
If, for example, the prices on the general stock market go up, this does not necessarily mean that the stock prices of all companies that can be traded on the market are also pulled up. It has therefore been observed quite often in history that certain stocks gain more than others or more than the market as a whole, some stocks follow the performance of the market as a whole or underperform the market as a whole or other stocks. In the worst case, it is even possible that an investor could lose a portfolio during a boom in the overall market – precisely when he bet on the wrong securities or sectors.
The same can be observed for bear phases on the overall market. Here, too, there are papers or entire sectors that are bucking the general market trend, and thus it is even possible, ideally, to increase the portfolio assets during a slump in the broad stock market, despite increasingly persistent falling prices.
A tool for betting on the favorites rather than the losers is the concept of industry rotation. This concept was explored in more detail by Sam Stovall, among others, in the classic work “Standard & Poor’s Sector Investing: How to Buy The Right Stock in The Right Industry at The Right Time” in 1996. A later and highly acclaimed academic study entitled “Sector Rotation over Business Cycles” by Jeffrey Stangl, Ben Jacobsen and Nuttawat Visaltanachoti also shows that stocks traded on the major US stock exchanges in certain sectors have performed particularly well during the different economic periods.
excess returns possible
According to research by Stangl, Jacobsen and Visaltanachoti (2009) for the period 1948-2007, a very specific strategy could have resulted in an annualized outperformance of about 7 percent. To do this, you simply had to bet on the broad stock market during an early economic upswing. In the phase of the middle economic upswing, the sectors “Candy & Soda” and pharmaceuticals would have been the favorites for the depot. In the late upswing, the focus should have been on the mining sector and cigarette producers. In the early recession, investments should have been made in the shipping containers, food, utilities, and entertainment industries, and in the late recession, personal services, food, and tobacco should have been held in custodians.
The special industry rotation strategy of Stangl, Jacobsen and Visaltanachoti (2009) deviates in some points from the usual market logic or assumed connections via a clever rotation strategy. Apparently, in the early phase of the economic upswing, not only did transport values develop particularly well, but an investment in the overall market would have been the ultimate. It is also interesting, among other things, that in the early stages of a recession it was not only defensive stocks – such as the food industry or utilities – that made the running, but instead also “shipping containers” and the entertainment industry tended to be among the favored sectors.
Conclusion
So, with an industry rotation strategy, there could be some significant outperformance. The concept of sector rotation for equity investors with a long-term focus has proven to be very profitable based on historical back-calculation. However, it remains to be seen whether this will continue to guarantee outperformance in the future.
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