Defensive stocks: These are stocks which tend to be resilient to economic downturns. They are ‘safe’ shares - which won’t go down as much as the market average in bad times, but won’t gain as much as the market average in good times; food companies for example, or utilities providing essential services like electricity suppliers or water companies.  

Cyclical stocks: These are stocks whose profitability – and so share price – tends to track the growth of the wider economy; the classic example being building companies. In boom times they (and their shares) do really well, but in recession they drop more sharply than the market average…and stay there until the next boom. So they will only be an uncertain investment across business cycles – not during a strong up or downturn.

Counter-cyclical stocks: These are stocks that do well during bad times and not so well during good times. Fantastic for a diversified portfolio – but it is difficult to find an entire sector which can be called counter-cyclical. An example here may be an accountancy firm with a large insolvency or receivership practice.

These categories are useful when it comes to understanding how a company may perform in different stages of the economic cycle. Share prices are based on expectations of company earnings and the state of the wider economy is a key factor in giving any one company the background potential to make profits. But you must be careful as there really is no such thing as a single, broad economy which all companies operate in.

Economic activity varies between geographic regions and industry-sectors. A single, unitary, national economic environment can be a bit of a misleading idea. Some companies are closely tied to a region and/or niche market, others are global and/or highly diversified. Factor company-specific risks into this and you can see that these categories are probably most useful for taking a sector rather than stock-specific view to your portfolio risk exposures.

Another problem with these frequently-used categories is that there is no clear-cut relationship between the current level of the stock market price and the level of broader economic activity. Mild economic growth can spur massive stock market growth and vice versa. As the American economist Paul Samuelson famously observed, " The stock market has predicted nine of the last five recessions".

The market will always be more volatile than any general measure of economic activity warrants, except in the midst of a full-blown recession where all share-trading volumes will drop dramatically. So the categories are really only helpful when taking a long-term view of portfolio risk exposure.