What Is Outperformance?

Outperformance is used to describe the returns of an investment producing better results when compared to another. The term is commonly used to compare an investment’s return to a benchmark index, such as the S&P 500. 

For example, investors could say they “outperformed” the market, if their portfolios produced better returns than the S&P 500.

There are a number of reasons why stocks can outperform the market. These may include: a company’s revenues or earnings growing faster than expected versus its peers, superb management decisions, market preferences, network effects, its industry sector was undervalued and has now rebounded, or even sheer luck.

So how can you find stocks that will outperform the overall stock market? 

Finding Outperformance

Investors are often able to achieve outperformance by determining where the economy/business is in its cycle, the strength of different sectors, and then picking the strongest stocks within those sectors to invest in.

An economic cycle, sometimes referred to as a business cycle, is the periodic growth and decline of a nation’s economy.  Economic cycles can be broken down into four parts, each of which is associated with the outperformance of certain sectors:

Early recession: 

The economy begins to slow and consumer expectations are falling. Growth is slowing as inflation climbs higher, and stock prices begin to look high compared to earnings. Interest rates are rising and the yield curve is flat or even inverted (meaning that long-term interest rates are equal to or lower than short-term rates). 

Historically, the following sectors have profited during these times: consumer staples, such as food producers and grocery retailers, healthcare and utilities.

Recession: 

Economic growth is down (GDP is contracting), and industrial production is at a low point. The unemployment rate is high and rising. Interest rates begin to fall, and the yield curve is normalizing (meaning that long-term rates are higher than short-term rates). Although consumer expectations are low, they are beginning to improve. 

The best sectors in this phase include utilities, healthcare, and consumer staples early on and then cyclicals (such as energy and materials) near recession-end. 

Early recovery: 

The economy begins to improve, and consumer expectations continue to rise. Industrial production begins to grow. Interest rates are falling. Corporate earnings grow. People spend. 

The sectors to consider investing in at this stage include: other cyclicals like transportation as well along with technology. 

Late/full recovery: 

Interest rates are on the rise and the yield curve has flattened. Industrial production is slowing and consumer expectations are beginning to fall. Sectors to consider include consumer staples and precious metals.

Part of the big picture analysis involved in deciding where we are in the business cycle includes interest rates and inflation.

How Interest Rates Play a Role in Outperformance

Interest rates rise and fall as the economy moves through periods of growth and stagnation and are important in crafting a portfolio.

When interest rates rise, some stock sectors – considered to be defensive – rise. These include the likes of healthcare, consumer staples and precious metals. 

Also financial stocks may benefit as banks can earn more from the spread between what they pay to savers and what they can earn from highly-rated debt like Treasuries. 

On the other hand, there are stock sectors that rise when interest rates decline. These include technology, utilities (and other high dividend payers) and commodities. And since lower interest rates tend to boost economic growth, small and midcap stocks also benefit. 

How Inflation Plays a Role in Outperformance

Research from the investment firm Schroders found that equities outperformed inflation 90% of the time when inflation has been low (below 3% on average) and rising – that is where we have been for many years.

When inflation is on the rise, there are certain sectors that usually outperform the market. These include commodity-related sectors such as basic materials and energy, as well as some utility stocks.

Another industry to consider is real estate (equity REITs) – it is a real asset that produces steady income. 

Investors can gain exposure to these types of investments through ETFs and mutual funds. A simple search on Magnifi indicates numerous ways for investors to access an array of funds with low fees.

Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.

The information and data are as of the February 9, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.