The overall performance of Toronto Stock Exchange (TSX) is a weighted average of capital gains or capital losses across its ten industries.
These ten industries do not perform the same way, at the same time.
Some industries generally perform poorly while the other industries are doing well.
And, in case they are all doing well, some are doing better than the others.
As a result, these ten industries do not contribute the same way to the overall performance of the TSX.
Table 1, below, shows the share of each of the ten industries in the market return, on the TSX, over the period 1998:M1-2018:M12 (251 months).
It turns out that the financial industry accounts for the highest share, which is 20.7%.
This industry is followed by the energy, which accounts for 16.1%.
The material and telecommunication service account respectively for 15.9% and 15%.
These four industries, which generate more than two-thirds of the market return, are known to be cyclical.
Their stocks perform extremely well during up-markets and lose lot of value during down-market.
| Industry | Share (%) |
|---|---|
| Consumer Discretionary | 12.9 |
| Consumer Staples | -1.4 |
| Energy | 16.1 |
| Financial | 20.7 |
| Gold | .3 |
| Industrial | 9.1 |
| Information Technology | 13.5 |
| Material | 15.9 |
| Telecommunication Service | 15.0 |
| Utilities | -2.2 |
The shares of consumer staples and utilities in the market retun is negative, which means that these two industries tend to perform poorly when the overall market is doing well. Consumer staples and utilities are known to be the defensive (or non-cyclical) sectors of a stock market. They operate in business areas that are still in demand during economic downturns (non-essential goods, water, electricity, gas).
The performance of defensive stocks Is stable regardless of the overall state of the market.
These industries generally perform better than the other industries during market downturns and, conversely, they generally perform poorly during market upturns.
The following table shows how the contribution of each of the ten industry of the TSX to the market return varies depending on whether the market is down or up.
Down-markets are when the market returns are negative and up-markets are when they are positive.
| Industry | Down-Market | Up-Market |
|---|---|---|
| Shares (%) | Share (%) | |
| Consumer Discretionary | 21.1 | 6.8 |
| Consumer Staples | -8.2 | 5.0 |
| Energy | 16.9 | 15.3 |
| Financial | 19.2 | 24.0 |
| Gold | .6 | .6 |
| Industrial | 1.2 | 13.8 |
| Information Technology | 15.6 | 10.9 |
| Material | 16.9 | 13.4 |
| Telecommunication Service | 13.2 | 15.5 |
| Utilities | 3.5 | -5.4 |
It appears in Table 2 that the consumer discrepentionary accounts for the highest share of the capital loss on the TSX, which is 21.1%, and a lower share of the capital gain, 6.8%. The financial industry, which is also cyclical, accounts for 19.2% of the capital loss but for the highest share of the capital gain, 24%. The industrial stocks turn out to be the cyclical stocks that contribute the least to the capital loss on the TSX, 1.2%, and contribute high to capital gain, 13.8%. The contribution of the gold industry is symmmetrical, .6% in both down-markets and up-markets. Even though consumer staples and utilities are both defensive stocks, Table 2 reveals that they do not behave the same way over down-markets and uo-markets. The returns on consumer disretionary stocks relate negatively to the market retruns, during down-market and positively during up-markets. That is the inverse for the utilities.
A part from the sign of the market return, another distinguishing feature between down-market and up-market is the level of volatility.
Note that 39.8% of the time, monthly retuns on the TSX were negative over the period 1998-2018 and they are positive over the rest of the time.
The level of volatility is higher when the market returns are negative, 3.8, than when they are positive, 2.2.
In Table 2, the sign of returns is used to distinguish down-markets and up-markets.
This way of distinguishing between the two states of the TSX is deterministic.
Another way of estimating the contribution of the industries to market return over different states is to use Markov chains, which model the probability of moving from one state to the other.
Table 3 displays the estimates of the shares of the industries in the market return over high and low volaty states, which are computed using a Markov-switching model.
| Industry | High Volatility | Low Volatility |
|---|---|---|
| Shares (%) | Share (%) | |
| Consumer Discretionary | 22.7 | 4.9 |
| Consumer Staples | -8.8 | 3.1 |
| Energy | 11.5 | 20.6 |
| Financial | 17.9 | 26.6 |
| Gold | 2.0 | -2.6 |
| Industrial | 5.1 | 8.0 |
| Information Technology | 24.5 | 7.2 |
| Material | 11.9 | 20.7 |
| Telecommunication Service | 7.7 | 6.7 |
| Utilities | 5.5 | -4.9 |
The estimates in Table 3, computed using a Markov-switching model, differ slightly from those in Table 2, computed distinguishing between negative and positive returns. But, the give the same information as regards to the pattern of the behavior of consumer discretionary, consumer staples, financial, and utilities industires. The pattern of the contribution of the gold industry has changed.
Knowing how various types of stocks behave over the different states of a financial market is a superior knowledge that could heolp fund mangers outperform the market.
For instance, in periods of down-market or high volality, holding stocks from the consumer staple industry is more rewarding.
Conversely, holding stocks of financial and energy companies in up-markets or during low volatility periods is a profitable investment strategy.
Holding industrial stocks could be less catastrophic during down-markets, but investing in utilities companies thinking they are defensive stocks is mistaken.
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