An investor recently asked Morningstar analyst Kevin McDevitt, CFA, about the performance of different industry sectors and different investment groups, like growth and value, during bull markets.

According to McDevitt, the results of his research are quite similar to what he found when looking at bear markets.

“As you might imagine, the results during the last five bull markets — the last of which is ongoing — are to some extent mirror images of what we found for the last five bear markets,” he explained in a recent Morningstar Fund Spy article.

“The best-performing sector during the 1998-’00 rally, technology (as measured by the Russell 3000 Technology Index) — which gained an earth-shaking 140.6% annualized gain during that 18-month period — was subsequently the worst-performing sector during the 2000-’03 bear market, falling an annualized negative 78.1%,” he added.

As he reminds investors and advisors, there are certain “near truths” to keep in mind about the markets: Reversion to the mean “is at least a strong tendency as bull markets become bear markets and vice versa,” says McDevitt.

Performance by sector in last five bull markets. Source: Morningstar

Growth vs. Value Stocks

The Morningstar analyst says he is a bit surprised that growth stocks — as tracked by the Russell 3000 Growth Index — performed better than their value counterparts in three of the last five bear markets or corrections.

Value stocks, though, have beaten their growth cousins during three of the last five rallies, including the current one, he points out.

Value-oriented sectors led the way in each of the five bull markets, with energy beating the pack with 31.1% annualized returns during the 2003-’07 bull market thanks to the spike in oil prices.

Also coming in with a strong performance in a bull market is the materials sector, which did particularly well in 2009-’11 and 2016 to now.

“In fact, materials beat the Russell 3000 in three of the last four bull markets, with its only dud in the 1998-2000 rally. Who would have guessed?” McDevitt said.

This sector, he adds, is presently seen as the most overvalued by Morningstar’s equity analysts.

Some market participants may wonder: Is it common for the worst-performing sector in a bear market to be the best performer in the next bull market? No, the analyst says, pointing out that it didn’t happen once, “at least not during the past five bear/bull cycles.”

And what about the reverse scenario? Has the worst-performing sector in a bull market turned into the best performer in the next bear?

Yes. Consumer staples, for instance, lost an annualized 16.5% during the 1998-’00 rally but was then the only sector to remain in the black during the 2000-’03 bear market, when it improved an annualized 19.5%.

“Chalk one up for mean reversion,” said McDevitt. He does, though, caution that this turnaround was the only such instance his research found. Trying to capitalize on mean reversion, he adds, “can sometimes get you in trouble, at least in the short run.”

The Case of Energy

This sector was the weakest performer of the 2011-’15 rally, when it gained 10.1% annualized vs. 21.9% for the Russell 3000. It then got “slammed” in the 2015-’16 correction, when oil prices dropped by close to one-third.

“Thus, especially over the short term, reversion to the mean is at best a tendency, certainly not a law. So, investors shouldn’t try to use it as a timing tool,” said McDevitt.

In other words, there just are not “no hard and fast rules” when it comes to which sector or style performs best during a rally (or bear market), “regardless of what happened in the previous one,” he says.

The Morningstar analyst concludes that diversification “remains an investor’s best friend” in both good times and bad.

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