Defensive sectors have significantly underperformed during the stock market recovery of the past two years.

A number of factors are prompting me to think that this situation is coming to an end and that there are now grounds to give priority to these sectors, particularly telecommunications, healthcare, and food/tobacco:

- Our conviction that the economic recovery remains fragile. Independently of structural impediments to growth, linked to overindebtedness, economic activity could start to be negatively impacted by the increase in the price of oil and rising interest rates. In such an environment, the relatively stable earnings of defensive quality companies will once again be appreciated;

- Defensive sectors regularly go through phases of under- or outperformance, but the underperformance of the past two years is extreme from an historical point of view;

- The logical outcome of this underperformance is that the valuation of these sectors is currently attractive in absolute terms and very attractive in relative terms (i.e. compared to the overall market and cyclical sectors);

- Unlike cyclical sectors, the profit margins of defensive sectors are still well below their previous peaks;

- Certain defensive sectors are strongly exposed to the emerging markets where there is higher growth potential.

A final note is that the underperformance of defensive sectors goes hand in hand with the huge underperformance of large caps in the past few years. The following graph shows that over the last 10 years, large caps (and the general market) have been drifting sideways while small and mid caps have generated an annualised return of around 8.5%. This was due to the fact that at the start of  2000, large caps were very expensive compared to small and mid caps. The opposite is true nowadays.