“Not all market corrections are the same,” said State Street’s Olivia Engel in the firm’s latest global equities update.
“Defensive stocks are not the only ones able to outperform the market in a correction.”
According to the senior manager of State Street global advisers and chief investment officer of Active Quotative Equity, the latest market correction has provided an opportunity to benefit from high-risk segments like energy.
“Historically, in drawdowns of more than 10 per cent, certain typically defensive segments tend to perform better than the market overall, and other typically cyclical segments tend to do worse,” Ms Engel said.
“Materials- and energy-sector performance tends to be mixed and, in the case of energy, highly variable. But in the drawdown triggered by Russia’s recent invasion of Ukraine, materials and energy have been the strongest-performing sectors,” she pointed out.
So far this year, the energy sector has outperformed the rest of the market by more than 15 per cent, following its stellar run in the aftermath of the TMT bubble collapse in 2000 and 2001, when it posted strong gains.
“Energy stocks have become more attractive from both a risk and return perspective.
“We have seen the expected return on energy stocks increase and have also seen their average beta fall. This means that adding energy stocks to a portfolio improves that portfolio’s overall risk and return attributes,” Ms Engel explained.
State Street’s estimates of energy stock returns began to improve in the second half of 2021, which were reflected in improved quality and sentiment measures. These themes, Ms Engel said, continued in 2022, and they persisted through the drawdown that took shape earlier this year. But since the Russia-Ukraine war began, these trends have accelerated further.
Technology stocks, however, have travelled the opposite risk and return path.
“Expected returns have dropped, and risk as measured by beta has increased, particularly in the software industry.
“Tech stocks have remained very expensive in our view, and sentiment measures – which declined precipitously over 2021 – have continued on the same trajectory during recent market events.”
Looking forward, Ms Engel said the conventional wisdom that defensive segments consistently outperform, and cyclical segments consistently falter during drawdowns “is not correct”.
“Even in the course of a deep drawdown, it’s important to remember that some trends are powerful enough to persist, even through extreme market conditions.”
