This post was written with contributions from Anqi Dong, CFA, CAIA. Anqi is a Research Strategist on the SPDR® Americas Research Team.

When it comes to identifying sector winners and losers, there are several different investment approaches. One widely used approach is business cycle analysis. Since economic cycles usually exhibit characteristics that impact sectors or industries differently, investors may identify sectors that are favored by the current economic phase.

We recently undertook a quantitative and systematic assessment of how different sectors performed through various business cycles. Using the Conference Board Leading Economic Indicator Index (LEI), we segregated business cycles and evaluated sector performance over multiple business cycles between 1960 and 2018. This provided a good sample size to evaluate sector performance persistency for different cycles.

Most research on business cycles only defines recession and expansion. But we believe there are nuances between a peak and trough, so we divided the business cycle based on the direction and magnitude of changes of the LEI:

  • Recession: The LEI Index declines to a trough at an accelerating pace.1 Economic activities fall significantly across the board, with declining economic outputs and aggregate demand from both consumers and business. Monetary policy attempts to increase aggregate demand by lowering interest rates.
  • Recovery: The LEI Index rebounds from a trough but below long-term trends. GDP growth and aggregate demand accelerate. Consumers become more positive about economic growth and start increasing their discretionary spending, while business stop cutting back on commercial activities.
  • Expansion: The LEI Index year-over-year changes are positive and above long-term trends. Economic growth reaches the cycle peak. Companies begin to allocate capital to expand business and improve productivity. Interest rates start rising from their relatively low level.
  • Slowdown: The LEI Index year-over-year changes pass the peak and begin moderating. Capacity utilization usually reaches cycle peaks and economic output gaps turn positive, meaning the economy is running beyond full capacity. Limited capacity constrains economic growth from accelerating further, leading to positive but decelerating growth. Monetary policy becomes more restrictive.

To get a comprehensive account of sector performance over multiple business cycles, we leveraged the performance data of Kenneth French 48 Standard Industrial Classification-based industry portfolios back to 1961 and mapped them to Global Industry Classification Standard (GICS®) sectors based on the latest definitions. We then equally weight industry performance to create a longer sector performance history to cover multiple recession, recovery, expansion and slowdown periods. Next, we assess that performance across 6 metrics, allowing us to fully evaluate not only how well the sector performed but also how consistent the performance is in each type of cycle. You can see the full details of our analysis for each of the four business cycle stages in the larger paper, Sector Business Cycle Analysis, available on our website.

The analysis ultimately provides a view of how sectors generally perform in different parts of the economic cycle, as illustrated in the graphic below, though unique characteristics and the idiosyncratic nature of each cycle warrants individual analysis on a case-by-case basis.

A closer look at sector performance during slowdowns

When we surveyed hundreds of clients at year-end 2018, many respondents highlighted an economic slowdown as one of their top concerns for 2019. The concern is valid and consistent with what the LEI index is telling us, which has been slowing down from its latest peak in September 2018. So let’s take a closer look at sector performance during historical slowdowns.

As economic growth decelerates and input costs increase, corporate profitability growth comes under pressure, remaining positive but slowing down. Given capacity and efficiency constraints, companies may spend more on capital expenditure to meet demand, but this is not always the case and there is usually a lag between the deployment of capex and rising productivity. The overall market return during slowdowns has historically been the second worst among the four phases. Investors start positioning more defensively and reducing their allocation to economic sensitive sectors in anticipation of the next economic downturn. This generally leads to the outperformance of Health Care and Consumer Staples.

Industrials is the third best performing sector, as it benefits from increasing investment in capital products over a slowdown phase. However, increases in capex did not occur or were not significant during every slowdown in our analysis. As shown in the following chart, during the 1984–1989 and 2014–2016 slowdowns, private nonresidential fixed investment declined significantly, leading to Industrials’ underperformance in both periods.

While Q4 private nonresidential fixed investment hasn’t been reported due to the partial government shutdown, other indicators are pointing to a slowdown in capex as businesses are hesitant to make investment plans amid concerns about elevated US-China trade tensions and weakening global economic growth. New orders of nondefense capital goods excluding aircraft declined in November for the third time in four months.2 The National Association of Business Economics’ (NABE) quarterly business condition survey suggested a further slowdown in business spending in Q4 and the next three months.3 Growing headwinds faced by Industrials have weighed down the sector performance significantly in the second half of 2018.

For more details about our assessment and in-depth comments on how different sectors performed during other phases of the business cycle, access the full paper: Sector Business Cycle Analysis. You can also access our most recent blog posts on sector investing here.

1When identifying recessionary periods, we made small adjustments to the beginning month to match with the economic peak identified by the National Bureau of Economic Research. The adjustments make the beginning month of recessions more aligned with the market downturn.
2US Bureau of the Census, as of 11/30/2018.
3$1.5 trillion US tax cut has no major impact on business capex plans: survey, Reuters, 1/28/2019.


Conference Board Leading Economic Indicator (LEI) Index
A composite of 10 economic components that are analyzed monthly to help foresee changes in the overall economy. The LEI components are: average weekly hours of manufacturing workers; average initial jobless claims; new manufacturer orders for goods and materials; speed of delivery of new goods to vendors; new orders of capital goods not related to defense; new residential building permits; changes to the S&P 500 Index; changes in inflation-adjusted money supply; the difference between long and short interest rates; and consumer sentiment. The data series is compiled by the Conference Board, a private, non-profit business research group.

Global Industry Classification Standard (GICS)
A financial-industry guide for classifying industries that is used by investors around the world. The GICS structure consists of 11 sectors, 24 industry groups, 68 industries and 157 sub-industries, and Standard & Poor’s (S&P) has categorized all major public companies into the GICS framework.

Standard Industrial Classification (SIC)
A system designed to categorize US companies by industry.