2. How has a company or sector changed over time?
It’s also important to recognize that even which stocks fit the traditional definition of “defensive” changes over time. For example, while healthcare stocks (XLV) are viewed as more defensive today, they were significantly more sensitive to economic and market conditions 15 years ago and their sensitivity may change again with the new healthcare law. Similarly, the technology sector (XLK) used to be the antithesis of defensive back in the 2000s, but since then, many of the surviving technology stocks have become large, reasonably stable businesses. As a result, the sector is less sensitive now to the market than it has been in the past. Meanwhile, in contrast, the financials sector has moved in the opposite direction and may move again amid increasing regulations. The key point here is that exactly how defensive a stock is, and even whether it’s defensive in the first place, actually changes over time.
Market Realist – Some sectors change from defensive to cyclical every now and then
The graph above shows the correlation between quarter-over-quarter GDP (gross domestic product), and quarterly returns of the S&P Financials Index for three different periods between 1998 and 2014.
In the period between 1998 and 2002, the financials (XLF) were indifferent to the GDP growth rate, with a correlation of -0.11. In 2002, financial stocks became more cyclical. Between 2003 and 2007, the correlation was +0.44. Since then, however, the correlation between the two has dipped to +0.31. Despite the dip, financial stocks still remain dependent on business cycles.
Meanwhile, there are certain sectors that could remain defensive. The utilities sector (XLU) and the consumer staples sector (XLP), for example, have stable earnings regardless of the business cycle. It’s difficult to see these sectors ever changing from defensive to cyclical.