Don’t Chase Heat: Defensive Sector Edition

During early 2016's volatility, many flocked to the perceived safer shores of Consumer Staples, Telecom and Utilities stocks-defensive sectors that tend to be less subject to the whims of the global economy. After all, you are going to need deodorant and toilet paper whether the economy is booming or destined to bust.^[i] So, given the fears of renewed recession that were so prevalent then, these three sectors unsurprisingly built up huge outperformance early on. But with the benefit of hindsight, it's clear this was a headfake. Investors who chased big returns in seemingly "safer" stocks have officially been taught a harsh lesson.

In the year's first six weeks-the correction out of the gate-Staples, Utilities and Telecom massively outperformed the MSCI World. Exhibit 1 shows this, plotting each MSCI World sectors' return with net dividends from 12/31/2015 through 2/11/2016, the correction's low.

Exhibit 1: Defensive Sectors' Early Outperformance Was Big

Source: FactSet, as of 11/23/2016. MSCI World Sector returns minus MSCI World returns, all with net dividends, 12/31/2015 - 2/11/2016.

Perhaps it was the perception of safety, perhaps the media's hyping of allegedly "low volatility" stocks and strategies and perhaps it was just investors chasing returns, but it seems to us many folks took notice. Except, as is fairly typical, most took notice after the move. Reacting to past performance is arguably the most common investor error, egged on by a financial media that by nature reacts to past movement. (They are, to some extent after all, reporting.)

Besides a brief Brexit bulge, ever since the correction passed and economic data dispelled the notion a recession loomed, Utilities, Staples and Telecom relative performance has crumbled. Exhibit 2 plots the relative performance of these three sectors with major events highlighted. When the lines are rising, the indicated sector is outperforming the MSCI World. Note that the lines really only materially rise in two small bursts.

Exhibit 2: Defensive Sector Outperformance Was Fleeting

Source: FactSet, as of 11/23/2016. 12/31/2015 - 11/22/2016. MSCI World Consumer Staples, Telecom and Utilities sector returns with net dividends relative to MSCI World return with net dividends.

As we type now, the day before Thanksgiving, defensive sector outperformance is gone year-to-date. The double-digit lead they built early in 2016 didn't last. And, since the correction ended in February, the Staples, Telecom and Utilities sectors are lagging the MSCI World by 16.5, 16.5 and 17.3 percentage points, respectively. Given this, and all the media hype earlier this year, it is highly likely many investors who rushed into these sectors have been badly hurt.

Exhibit 3: Defensive Sectors' Relative Boom Turned to Bust

Source: FactSet, as of 11/23/2016. MSCI World Sector returns minus MSCI World returns, all with net dividends, 2/11/2016 - 11/22/2016.