The defensive end
Typically, defensive industries―such as utilities and consumer staples―do well during a recession because people and companies restrict their spending to necessities. Since their revenue is relatively stable, many companies can afford to pay consistent dividends. Investors, therefore, gravitate toward them for stable income and lower potential volatility.
Market Realist – Cyclical sectors could benefit as the economy shows signs of rebounding.
“Beta” is a measure of a stock’s sensitivity to market movements. It is a measure of the volatility, or systematic risk, of a security in comparison to the market as a whole.
If a stock has a beta of 1.3, it could perform 30% better than the S&P 500 in up markets and 30% worse in down markets. Similarly, a stock with a beta of 0.9 indicates that the stock is expected to perform 10% worse than the market’s return during up markets and 10% better during down markets. In other words, stocks or indices with a beta higher than 1 tend to be more volatile (VXX) and are cyclical in nature.
The graph above compares beta–considering monthly returns for ten years–for major sectors within the S&P 500 (SPY). The financials (IYF), industrials (DIA), technology (QQQ), and consumer discretionary (XLY), which are all cyclical, are high beta sectors. The financials have very high beta of 1.4, while the industrials have a beta of 1.2. Technology and consumer discretionary have a beta of 1.1 each. Energy stocks have a beta of 1.
On the other hand, defensive sectors including healthcare (IYH), consumer staples (XLP), and utilities (IDU) have low betas. Healthcare has a beta of 0.7, while consumer staples and utilities have betas of 0.6 and 0.5, respectively.
Remember that the S&P 500 closely tracks the movements in GDP. As we saw in the previous part, the defensive sectors are less susceptible to the ups and downs of economic growth. This is because, no matter what, households have to spend on items like groceries, power, and medicines.
This is why defensive sectors have steady earnings that usually grow slowly. Cyclical sectors have volatile earnings, but they can see high growth in earnings when the economy improves.