Cyclical vs defensive sectors

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Before investing one must understand how stock markets and different types of stocks perform during different stages of the market or economic cycle. 

What is an economic cycle?  The economy is generally in a long run go upwards but between same periods there are four different stages in which it fluctuates the stages are called expansion,  peak, contraction & trough.

In this article, we will be covering two types of sectors which are the defensive and cyclical sectors. And the difference between them (cyclical vs defensive sectors).

Cyclical sectors include industries that grow faster when the economy is growing and vice versa. Industries in this sector include construction, real estate, hotel, etc. As opposed to cyclical sectors, defensive industries grow steadily over a longer period of time or stay stable. This sector includes industries like pharma, healthcare, FMCG, etc.

1. What is the cyclical sector?

Companies or industries in a cyclical sector generally follow the economic growth of the country or the world. The fate of these Industries depends upon the general growth in the economy.  For example, from early 2003-04 the real estate and construction sector in India as well as in the US started booming because of the general economic growth & other related factors.

This growth in India was due to, the then government’s investment and other related factors which turned around in 2011. Till then many companies in this sector had given multi-bagger returns, the companies included L&T, Crompton Greaves, JSW Steel, etc.

The turnaround in a cyclical sector can be caused due to multiple factors. For example when the capacity is up to or almost 100% utilized and there have not been any new investment for the past few years.

The intensity of cyclicality in different sectors can be different, some sectors can be more cyclical as compared to others. For example, real estate finance is more cyclical as compared to retail credit.

2. What is the defensive sector?

Companies in this sector are essential for human basic needs.  Without these industries, it would be very difficult for us to live a normal life. Examples of the defensive sector are pharma,  health care, utility, etc.

Stocks that represent companies in this sector usually do not participate in the short-term market or economic growth exuberance.

These stocks underperform during the later face of a bull market and outperform during the recession or early stages of a bull market.

The downside risk in a recession in this stock is relatively less as compared to cyclical and vice versa in the case of an upside. 

Read about a related topic: Circle of Competence

3. Cyclical v/s defensive sectors with market cycles.

A simpler example to understand the differences between the two is as follows.

When the economy is growing we like to dine out in restaurants, hotels and go out for a vacation, but when the economy is not doing well we generally eat the basic food & stay in our houses and cut down on expenses.

So the companies in this example like hotels and restaurants are cyclical companies and FMCG & utility companies (like electricity companies) are defensive companies.

Cyclical companies outperform defensive companies in the later stage of the bull market where all the market participants are exuberant about the future economic growth. 

Investors who are interested in investing in a cyclical company should always know where the economy or the sector is presently there in the cycle. This is not the case in a defensive sector, the company in this sector usually gives a       steady return over a period of time.

When the bull market is at its full swing the companies in the cyclical sector are most favored as investors think that they will continue their growth trajectory in the future as well. In contrast to which the defensive sector at this stage may not be performing at far with cyclical stocks.

4. List of cyclical & defensive industries & stocks

a. Cyclical Industries & stocks

  1. Metal Industry – Vedanta Ltd, Hindalco, etc.
  2. Hotel Industry – IHCL, Mahindra Holidays Ltd, etc
  3. Cement Industry – Shree Cement Ltd, ACC Ltd, Ambuja Cement Ltd, etc.
  4. Real Estate – Sunteck Realty, Godrej Properties Ltd, Oberoi Realty Ltd, etc.
  5. Construction – NCC, NBCC, KEC International Ltd, etc.
  6. Banking etc.

b. Defensive Industries & stocks

  1. Pharma – Sun Pharmaceutical Industries, Aurobindo Pharma Ltd, AARTI DRUGS LTD.
  2. Healthcare – Apollo Hospitals Enterprises Ltd, Dr. Lal PathLabs Ltd, Fortis Healthcare Ltd
  3. FMCG – Marico, D-mart, HUL, etc.

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5. Cyclical industries in India

There are many industries in India that may not have the same cyclicality in the same way which is experienced in other countries because of structural reasons.

For example, the banking industry in other countries is more cyclical as compared to the Indian banking industry. The reason behind it is the penetration of banking services in India is lower as compared to other countries. 

The same reason can be formed for other industries like automobile, insurance, etc. for India.

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