Cyclical stocks have been outperforming their defensive counterparts in European and US markets this year, defying the widespread economic disruption caused by the ongoing Iran conflict, according to market analysts. The surprising rally has been driven by enthusiasm around artificial intelligence and capital investment in infrastructure in the US, while European banks and industrial firms have benefited from resilient economic data and a boost from higher defence spending, said Jason Hollands, managing director at Bestinvest. He added that investors appear to have taken the view that the crisis will not be long lasting.
What are defensive stocks?
Defensive stocks are shares in companies whose businesses are less likely to be affected by the ups and downs of the economy. These firms provide essential goods and services that people continue to buy regardless of the economic cycle – such as food, household goods, medicines, utilities and broadband. UK examples include grocery retailer Tesco, consumer products giant Unilever, pharmaceutical group GSK and weapons manufacturer BAE Systems.
Unilever reported underlying sales growth of 3.8% in the first quarter of 2026, driven by strong volume growth, and expects full-year underlying sales growth of between 4% and 6%. BAE Systems saw sales rise 10% to a record £30.7bn in the 2025 financial year, with its order backlog swelling to a record £83.6bn, reflecting sustained demand in a period of elevated global defence spending.
What are cyclical stocks?
Cyclical stocks, by contrast, are closely tied to the health of the economy. They tend to perform well when growth is strong because they rely on discretionary spending, but suffer when the economy slows. Sectors include banking, travel, leisure, manufacturing, housebuilding, infrastructure, automobiles and luxury goods. UK examples include airline easyJet, fashion brand Burberry, home improvement retailer Wickes and housebuilder Persimmon.
Their performance so far this year has surprised some experts. However, the broader economic backdrop remains challenging. The National Institute of Economic and Social Research (Niesr) has warned that the UK faces a £35bn economic hit and a risk of recession in 2026 because of the fallout from the Iran conflict. Energy prices have surged: Brent crude oil and UK wholesale natural gas have risen sharply, pushing petrol prices up 10% and diesel prices up 20% between late February and late March 2026. Farmers have reported substantial increases in fuel and fertiliser costs.
Inflation, which slowed to an annual rate of 2.8% in April 2026, is expected to rise again. The Bank of England held interest rates at 3.75% in April, but some policymakers have indicated potential future increases, and experts predict the base rate could reach 5.25% this year. Governor Andrew Bailey has said that while inflation above the 2% target is tolerable given weak economic growth, that tolerance would diminish if price rises become more permanent. Swap rates have already risen, reflecting expectations of further hikes.
Consumer spending growth was just 0.3% in the third quarter of 2025, and overall card spending edged lower in April 2026 as households became more cautious, particularly on discretionary categories like travel. Retail sector spending fell 0.7% year-on-year in April, the largest decline since November 2024, as renewed cost-of-living pressures took hold. Three in five consumers are taking action to reduce outgoings. Among businesses, 80% report being negatively affected by the Iran conflict: 64% cite rising energy and fuel costs, 34% higher shipping and logistics costs, and 33% supply chain disruptions. As a result, 37% of businesses expect to pass on cost increases to customers, and 20% have paused investment plans.
Cyclical company earnings reflect this mixed environment. easyJet reported a first-half headline loss before tax of £93m for financial year 2026, wider than the prior year’s £61m loss, which the airline attributed to strategic route investments, capacity growth and a £25m fuel hit from the Middle East conflict. Burberry, however, reported an “inflection” year: revenue was flat at £2.42bn, but adjusted operating profit jumped to £160m from £26m, and comparable store sales rose 2%. Wickes saw full-year 2025 revenue rise 5.9% to £1.64bn, with adjusted profit before tax up 14.4% to £49.9m, and has announced an ambition to expand to 300 stores. Persimmon completed 12% more homes in 2025, with underlying profit before tax up 13% to £445.6m, but noted that the impact of the Iran conflict on customer sentiment “remains to be seen.”
Investment considerations: defensive versus cyclical stocks
For investors weighing which type of stock to buy, the key differences come down to risk, income and the economic outlook. Defensive stocks tend to offer predictable earnings and consistent demand, making them more suitable for conservative investors. They often pay regular dividends, which Derren Nathan, head of equity analysis at Hargreaves Lansdown, says can be popular with those taking a pension. Hollands adds that defensive stocks “may not deliver the same level of gains as a cyclical during an economic boom, but they can help cushion portfolios in tougher times.” They typically experience lower volatility, though they can trade at a premium during economic downturns.
Cyclical stocks, by contrast, are “more sensitive to changes in interest rates, inflation, and consumer spending,” according to Hollands. They are less in demand during a recession but can deliver stronger performance when the economy recovers. Drawbacks include higher volatility and potential fluctuations in dividend payouts, as earnings expectations shift.
However, Nathan warns that a defensive stock is not always a defensive investment, nor is a cyclical stock always risky. “If an investor overpays for a stock offering more predictable earnings, that becomes a risky investment,” he says. “If the market is pricing a cyclical company as though the cycle will never recover, that’s potentially a low-risk opportunity.”
Ultimately, the choice depends on an investor’s outlook. Hollands says it is sensible to own a blend of companies, which can be achieved through funds rather than individual stocks. Funds such as the IFSL Evenlode Income fund focus on stocks with resilient, repeatable earnings and avoid highly cyclical parts of the market. Conversely, value funds such as the Temple Bar Investment Trust offer high exposure to areas like banking and energy when cyclical stocks are out of favour. Nathan agrees that a diversified portfolio should include both defensive and cyclical holdings. “Investors should take a long-term view, focusing on companies with good management, strong financial discipline and compelling customer propositions,” he says. “Those who think they have the superpower of predicting peaks and troughs in the cycle may dip in and out of cyclicals relatively regularly, but it’s well established that time in the market rather than timing the market is a more successful strategy.”
