The economy has many different areas to consider. When we think of investing in the capital markets, we tend to think of stocks, bonds, currency, property and so on, but once you decide to actually invest in stocks how do you determine which stocks? Which kinds of stocks? Sector analysis can help you with this. A sector is a simple thing – it’s just a grouping of similar companies that we measure together and think about together to help us break the market into groups. Sectors are groups. Groups of companies. There are different ways we could group these companies, but the best thing to do, so that you can speak the same lingo as everyone else, is to group them the same as most investors do.
The first distinction when grouping, is to move them into one of two camps: Aggressive or Defensive stocks.
Are those that tend to move up and down faster, and the type of product and service they provide and sell is based on good economic conditions for the company to work at peak performance. Think of the company you either work for, or own, is your performance based on good economic conditions? Or do you provide a service or product that will move regardless of the economy?
Aggressive sectors include the following five groupings:
- Basic Materials
- Consumer Discretionary
Each of these five sectors tends to do better, perform better and go up during times of economic expansion. But, and equally, as important, they tend to go down more (in stock price) during times of economic contraction when compared to more defensive sectors.
Industrial companies would include the likes of Caterpillar (CAT), Deere (DE) and similar companies that produce products and provide services that tend to go along with infrastructure building. These are broad groupings by the way, and they do need to be divided into sub-groups. Those are called industries. Basic Materials companies are those type that pull raw materials out of the ground. It’s the stuff that if you drop it on your foot it hurts. Most things hurt when you drop them on your foot. Energy companies include oil – everything from conglomerates to refiners and across all industries – natural gas, solar, alternatives and such. Consumer Discretionary companies are those that provide products that we like to buy as consumers – but if we don’t have the money we leave them in the store or on the shelf. Think retail companies. A good example of a Discretionary company would be Brunswick. They make boats, pool tables and bowling balls (among other products). We buy their products when we have extra money, but we don’t always need to have a new shiny toy. Technology is the backbone of the economic growth cycle (that and financials) and includes everything you can imagine from a technology perspective. We invest in Technology companies when we want to become more efficient and when we want to grow our business.
- Health Care
- Consumer Staples
You can think of these groupings of companies as defensive because the products or services they build their business on are not entirely dependent on the economy doing well. Health Care companies provide medical care, insurance and such, and as a consumer, we tend to keep our health care even in down times. Utilities are the kinds of companies that provide your electricity or natural gas – and tend to pay dividends. Consumer Staples provide products that you and I will use, regardless of economic health, like food, toiletries and such. Financials are a wild-card but tend to be thought of as defensive. Commercial banks and investment banks are two very different kinds of companies, but they both make money and continue to operate when the markets go down. During the financial markets crash, some investment banks went under – Lehman brothers for example – and it does expose the potential risk from those companies.
When you invest in different sectors, you are trying to invest in that grouping of stocks, instead of individual companies. There can be some big advantages to this. If you are trading or investing in an IRA or some type of longer-term account, using the sector can help you avoid individual company risk. Each of the sectors described does also have ETF’s that track those sectors – and many of those ETF’s have options that you can use to trade with. Consider sectors when selecting companies to build your investment plan and trading plans around.