Diversification is one of the key building blocks of a successful investment strategy.

There are many types of diversification to help you minimize your investment risk. These include:

The topic of this article is sector diversification. More specifically, this article will compare the performance of the different sectors of the S&P 500 over the past decade.

Interestingly, certain sectors of the stock market have delivered superior performance over long periods of time. Often, these sectors tend to be defensive and recession-resistant, so their outsized performance is accompanied by minimal additional risk. Accordingly, these sectors may merit an overweight allocation in your portfolio.

This article will provide data on the performance of different stock market sectors over time and perform an attribution analysis to see why certain areas of the market outperform.

Performance In Recent Years

Heatmaps are one of the most insightful visual representations of financial information.

The following diagram shows the annual performance of the 11 sectors of the stock market (as measured by the subindices of the S&P 500) over the past ten years.

Source: Novel Investor

There are multiple interesting observations that we can make from this data. Each will be discussed in its own section below.

The Best Performing Sectors Since 2007

There are four different S&P 500 subindices with double-digit total returns in the time period sampled (2007-1H2017). These subindices are:

Why is this?

Each sector has its own unique fundamental characteristics that help to drive long-term shareholder returns.

Firstly, the consumer discretionary sector tends to outperform during bull markets as consumers allocate more disposable income to discretionary expenses.

When you think of consumer discretionary companies, think of ‘fun’ businesses. The four largest companies in the S&P 500 Consumer Discretionary Index right now are Amazon (AMZN), Comcast (CMCSA), Home Depot (HD), and The Walt Disney Company (DIS).

The performance of the S&P 500 Consumer Discretionary subindex is compared to the broader S&P 500 during the current bull market in the following chart.

Source: YCharts

Consumer discretionary stocks have outperformed the broader stock market in the current bull market as consumers have more money to allocate to nonobligatory purchases.

The Consumer Staples subindex has a different driver of total returns.

Notably, this sector generates persistently high returns on equity (ROEs). The ROE of the consumer staples sector is compared to the ROE of the consumer discretionary sector and the broader stock market in the following diagram.

Source: Investor Field Guide

What is truly surprising about the high ROEs of the consumer staples sector is its remarkable consistency to stay in that high-teens to low-twenties area.

One would expect that such attractive economics would invite ample competition, making business less profitable and driving ROEs downward. Clearly, this has not been the case, as ROEs have remained persistently high over long periods of time.