Sectors and cycles

Sector leadership rotations near inflection points

Sector performance patterns
A historical analysis of the cycles since 1963 shows the relative performance of equity market sectors has tended to rotate near turning points in the economy, with different sectors assuming performance leadership in different market phases. While it was rare that any one sector outperformed 100% of the time during any one particular phase, there are certainly some patterns of leadership consistency within each phase (see chart below). For each sector, our analysis examined both the magnitude of performance (average and median) relative to the broader equity market, and the frequency of outperformance (how often each sector performed better than the broader market).

Early-cycle phase
Prior to the end of a recession and during the early months of a recovery, sectors that typically benefit from a backdrop of low interest rates and the first signs of economic improvement tended to lead the market’s advance. Interest-rate-sensitive sectors, such as the consumer discretionary and financials sectors, historically have outperformed the market by roughly 13 percentage points and 7 percentage points respectively, on average, and have done so 86% of the time (see schart below). These sectors do well in part due to industries that benefit from increased borrowing, which includes banks (financials) and consumer durables such as autos and housing (consumer discretionary). The information technology sector also has fared well in the early-cycle phase, boosted by industries such as semiconductors and electronic components that are among the most highly leveraged to an economic recovery. Most of tech’s early-cycle outperformance has tended to come in concentrated doses early in the period, but has faded after the recession ended. The industrials sector includes some industries, such as air freight, trucking, and rail transportation, where demand escalates rapidly in the very early stages of recovery, with the best performance typically coming during the first three months after the economy emerges from recession.

Mid-cycle phase
As the economy moves beyond its initial stage of growth and the Fed prepares to begin raising interest rates, the leadership of interest-rate sensitive sectors tapers. At this point in the cycle, economically sensitive sectors still lead, but a shift takes place toward some industries that don’t tend to see a peak in demand for their products or services until the expansion has become more firmly entrenched. Energy, materials and industrials assume market leadership 71% of the time during this phase (see chart below). For example, demand for certain industrials, such as heavy equipment, and engineering & construction services, tends to pick up during this phase because it takes some time for companies to feel confident and profitable enough to initiate spending on large-scale infrastructure projects. Similarly, such longer-term projects also prompt demand for energy commodities and other raw materials, such as copper, aluminum, and steel. Technology also has tended to perform well during this phase, having certain industries, such as software, and computers & peripherals, that typically pick up momentum once companies gain more confidence in the stability of an economic recovery and are more willing to spend capital.

Since 1963, different sectors have assumed leadership during different market phases, in terms of both frequency and magnitude of outperformance.

Late-cycle phase
As the economic recovery matures, some economically sensitive sectors, such as materials and energy, continue to do well as the late-cycle economic expansion helps maintain solid demand and prices for commodities and raw materials. Elsewhere, as investors begin to glimpse signs of an economic slowdown, many also rotate to more defensive-oriented sectors, such as consumer staples and health care, where profits are more tied to basic needs and are less sensitive to the economy (see chart above). All of these four aforementioned sectors have outperformed the broader market during this phase by seven percentage points or more on average, and have done so 71% or more of the time.

Recession phase
As economic growth stalls and contracts, sectors that are more economically sensitive fall out of favor and those that are defensive-oriented rotate to the front. These less economically sensitive sectors—including consumer staples, utilities, telecommunication services and health care—are dominated by industries that produce products, such as toothpaste, phone service, electricity, and prescription drugs, that consumers are less likely to cut back on during a recession. As a result, investors tend to gravitate to these sectors because their profits are likely to be more stable than those in other sectors during a recession. The consumer staples sector has a perfect track record of outperforming the broader market throughout the entire six-month recession phase. High dividend yields offered by utility and telecom companies have also helped these two sectors hold up relatively well during prior recessions (see chart above).