How are your sectors doing?
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Stock sector performance, like the market itself, isnât monolithic. Sectors rise and fall based on industry fundamentals and broader trends in the economy, with different sectors often heading in different directions at the same time. Sector-based investing is a popular strategy, but you need to understand how sectors interact based on things like recessions, interest rates, and changing commodity prices before you dive in.
Key Points
- Stock sector investing is popular, but itâs important to understand how sectors interact based on economic trends and events.
- Tracking sector performance over time can help tell the story of whatâs happening in the economy.
- Different sectors often move in opposite directions on a given day based on industry fundamentals.
Once you develop a basic understanding, youâll be able to move money out of some sectors and into others to try to benefit from prevailing economic and industry winds. Or you might decide on a balanced strategy, spreading money across multiple sectors in hopes of calmer sailing amid rough economic waters.
Seasoned sector investors sometimes choose sectors based on phases, or cycles, of the economy. Some sectors perform better than others during a recession, while other sectors do best during economic recoveries.
Tracking sector performance
Just as you can follow the S&P 500 Index (SPX) second-by-second or day-by-day, you can also track sector performance. Itâs easy to find websites that track each sector throughout the trading session, daily, and over the months. Find one you like and start monitoring it regularly to get a sense of where the different sectors have been and how theyâre performing.
If you watch several sectors over time, theyâll tell the story of whatâs happening in the economy. Here are a few recent âsector storiesâ:
- Energy. This was a dog of a sector in the 2015â20 period due to falling crude prices amid rising production, followed by sinking oil demand during COVID-19. But in 2021 and 2022, the energy sector skyrocketed amid global turmoil (Russiaâs Ukraine invasion, plus a surge in demand after pandemic lockdowns ended) that raised supply concerns. Crude prices soared to $120 a barrel by the spring of 2022, nearly double the previous yearâs level, boosting profit margins at big oil, natural gas, refinery, and pipeline companies. When investors see sector profits improving, they often bid up stocks in the sector.
- Financials. This sector, which includes the largest U.S. banks, insurance, and credit card companies, had some rough years between 2015 and 2020, hurt by a low interest rate environment as major central banks pushed borrowing costs down near zero. Low interest rates often hurt profit margins for the banks. The financial sector enjoyed a bit of a revival after COVID-19, however, when the economy got a boost from government stimulus. This heated up the housing market and led to more consumer spending, meaning more business for banks and credit card issuers. Rising interest rates starting in 2022 also supported financials.
- Technology. This sector was a frequent champion during the 2010â20 period, propelled by great performance from stocks such as Amazon, Apple, and Microsoft amid relatively strong economic growth. Then in 2022, technology took it on the chin amid rising interest rates, which tend to hurt so-called âgrowthâ stocks that dominate the technology sector. A growth stock is one that has most of its business growth ahead and may rely on borrowing money. Because it costs more to borrow money when rates rise, that can tighten profit margins for companies with heavy debt loads.
Additionally, rising interest rates can hurt the home-building stocks in the consumer discretionary sector even as they help the bank stocks in the financial sector. A pandemic like COVID-19 may give consumer staples stocks a big lift as people rush out to buy toilet paper, canned food, and other essentials they need for a lockdown. But at the same time, the pandemic weighed on shares of many consumer discretionary stocks, such as restaurants, airlines, and hotels, as demand dropped. See the chart for the full snapshot of sector performance over the past 10 years.
SECTOR PERFORMANCE MATRIX. The S&P 500 Index has seen strong performance over the past 10 years, but some sectors saw outsize returns while others underperformed. Energy, for example, barely budged over the period, but note its one-year performance has led the pack. Data source: S&P Global. Image source: Barchart. For illustrative purposes only. Past performance is no guarantee of future results.
Source: Barchart.com
Sector investing example: The daily grind
Before you take on sector investing, itâs important to learn how various sectors respond to developments on a daily basis, not just over the long term.
Sectors often move in opposite directions on a given day based on fundamentals, whether itâs industry-specific news or general economic trends. Here are a couple scenarios to consider.
Scenario 1: The Oil Spike
- Primary impact. Crude oil prices rocket 3% higher in a single day after news that Europe might ban imports of oil from Russia.
- Secondary impact. The energy sector rallies, but thereâs a plunge in the consumer discretionary sector, which includes stocks like airlines and cruise ship companies.
- Why? Higher oil prices tend to help the oil companies (which can sell their product for more money) but hurt the airlines (which have to pay more for a necessary resource).
Scenario 2: A Red-Hot Inflation Report
- Primary impact. The latest inflation data from the U.S. government shows prices rising more than most market participants expected.
- Secondary impact. The real estate sector responds positively, climbing on the news. But the industrial sector has a bad day.
- Why? Inflation can be positive for real estate because it tends to lift home prices. Some investors buy real estate stocks during inflationary times to benefit from the rising value of homes and land. Industrial companies, however, can get hurt by inflation because it raises their input costs (the cost of supplies they need for manufacturing).
Sector performance isnât always black and white. Different stocks from the same sector can sometimes move in different directions on the same dayâfor example, if one company delivers a solid earnings report and its competitor comes up short when it reports earnings.
Also, each of the 11 sectors in the S&P 500 has numerous subsectors, including:
- Biotech (a subsector of health care)
- Semiconductors (a subsector of information technology)
- Specialty retail (a subsector of consumer discretionary)
These subsectors sometimes respond to specific developments affecting the companies within them, even while the overall sector goes a different way.
For instance, when COVID-19 struck in 2020 and biotech companies began working toward a vaccine, some biotech stocks got a lift, but it didnât necessarily translate to the entire health care sector. Online retailers did robust business during lockdowns, when many people had to shop from home. Conversely, many brick-and-mortar retailers had a few bad months before they reopened with a concentration on curbside pickup programs.
Investing in stocks is inherently risky. Thereâs always a chance you could lose moneyâsometimes lots of it. Some investors try to reduce their risk by choosing certain sectors over others. Others pick the riskier ones in search of greater long-term growth potential.
The riskiest sectors, such as tech, can also offer higher rewards, although nothing is for sure. Less risky sectors, like consumer staples and utilities, donât often soar, but tend to plod along more steadily and pay higher dividends.
Some active investors might dial up the risk during boom timesâfavoring tech and consumer discretionary, for exampleâbut shift during times of market stress to a defensive status, preferring utilities and staples, for example.
This article was most recently revised and updated by Dan RosenbergThis article was most recently revised and updated by Doug Ashburn
