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Chart of the Week

Weekly chart using economic data to address timely market topics from the Wells Fargo Investment Institute Global Investment Strategy team.

September 30, 2020

The business cycle — Sectors deviate from the script

PurchasingSources: Wells Fargo Investment Institute, Bloomberg. Data as of August 31, 2020. This chart was excerpted from the Equities In Depth report, “The shifting landscape of equity sector composition” (September 17, 2020).

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Sectors that historically have performed best throughout the business cycle

History tells us that sector performance can fluctuate based on where we are in the business cycle, but we have noticed that trends changed over the 2009-2020 cycle. The top section of the chart shows traditional sector outperformers during historical business cycles (1990 – 2020). The bottom section shows how the outperformers have shifted during the most recent business cycle.

In particular, Information Technology (IT) has become more of an “all-weather” sector — outperforming during the recent bull and bear markets (from 2009-2020). Consumer Discretionary has become less cyclical, performing well late into the last cycle. Meanwhile, Energy and Financials have faced secular challenges that have caused them to be consistent underperformers throughout the previous cycle.

What it may mean for investors

  • Defensive sectors — such as Consumer Staples, Health Care, and Utilities —have historically been consistent outperformers during recessionary periods. Even so, IT was well positioned heading into the last recession, and it has benefited from the accelerated transition to a digital economy.
  • Cyclical sectors tied to the consumer, interest rates, and economic growth — such as Consumer Discretionary, Industrials, IT, Communication Services, and Materials — have historically outperformed on a relative basis once the economy moves out of a recession. Financials had historically been a lead outperformer early in a recovery. Yet, very low interest rates over an extended period of time have made it more difficult for banks to recover profits.

Risk Considerations

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication Services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the communication services sector may also be affected by rapid technology changes; pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players; reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. Consumer Staples industries can be significantly affected by competitive pricing particularly with respect to the growth of low-cost emerging market production, government regulation, the performance of the overall economy, interest rates, and consumer confidence. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject a investment to adverse economic or regulatory occurrences affecting the sector. Some of the risks associated with investment in the Health Care sector include competition on branded products, sales erosion due to cheaper alternatives, research and development risk, government regulations and government approval of products anticipated to enter the market. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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