The premise makes enough sense. There was a time, in fact, when defensive sectors such as consumer staples and healthcare reliably outperformed cyclical growth industries — like technology — in challenging economic environments.
Assuming we’re nearer the end of an expansion cycle than the beginning of one right now, you may be tempted to own a little less tech going forward, and more of something along the lines of the State Street Consumer Staples Select Sector SPDR ETF (XLP +0.63%) or the Vanguard Consumer Staples ETF (VDC +0.66%).
The fact is, however, the market doesn’t quite work like this anymore. Responses to economic weakness are quick, and investors are aggressively predictive. Most nation’s economies are also so intrinsically linked to the rest of the world that it’s entirely possible a company can overcome a domestic economic headwind, or be dragged down by worldwide economic weakness.
In other words, this sort of sector-minded strategizing doesn’t quite pay off. It hasn’t since the 1990s, when everyone (for better or worse) became able to instantly know and then act on everything.
Not like it used to be
Don’t misread the message. In general, you might benefit some from repositioning your portfolio in front of an economic slowdown. For example, once the dot-com bubble finally burst in 2000 and technology stocks’ performance cratered, data from Callan indicates highly defensive utilities ended that same year up 57%.
Investors also understandably snapped up REITs (real estate investment trusts) in 2001 and 2002 to enjoy market-leading gains of 14% and 4%, respectively. Nothing else performed well in those two tough years, though. Even consumer staples stocks and ETFs like the aforementioned Vanguard’s VDC and State Street’s XLP lost value in 2001 and 2002, at least partially defeating their purpose as a defensive holdings.
Strategic investors suffered similar disappointment during 2008’s subprime mortgage meltdown. Utilities stocks technically held up better than most then, but the State Street Utilities Select Sector SPDR ETF (XLU +0.04%) still lost 15% of its value that year.
Image source: Getty Images.
And for what it’s worth, while they easily outperformed the S&P 500‘s 18% loss in 2022, utilities stocks still only gained less than 2% in that bear market year. Worse, those very same utilities stocks were the worst performers of 2021, and then again in 2023. You would have needed absolutely perfect timing for defensive positioning to pay off for you.
Pick stocks over sectors
This isn’t to say you shouldn’t own any defensive stocks if you fear a headwind is brewing. It’s mostly to point out that economic change is largely unpredictable. And to the extent it is predictable, it isn’t necessarily meaningful on a sectorwide basis. And this assumes, of course, you know exactly when to get in and get out — which nobody knows.
So, if you’re looking to play some cyclical defense, your best bet is picking a proven stock — or stocks — that have beaten and are overcoming economic headwinds blowing at the time. The modern market environment is more than fine-tuned enough to reward the right tickers while other names struggle.
Or better still, just stick with a portfolio of stocks that will be fine after any economic challenges have run their course. One year’s poor performers are often the next year’s leaders, after all.
