Sectors and Areas
Becoming a successful investor requires understanding numerous industry sectors and their cyclical nature.
Individual sectors, just like the overall market will go through stages of growth, plateau and decline. The better you understand what sectors exist and how they work, the more successful you will be in managing your portfolio.
A critical element of successful investing is understanding the relationship various industry groups have to the broader market and benchmark indexes. Winning investors realize that equity markets are fluid environments, meaning that some sectors perform well in certain market settings and when those settings change, other sectors will emerge as leaders. In other words, today's winning sectors can easily become tomorrow's laggards and vice-versa. Knowing not only what stocks make up a particular sector, but WHEN these stocks are worth investing is critical to effective portfolio management.
Sectors normally followed by investors include:
Companies that fall under the classification of basic materials are involved in exploration, processing and refinement of raw materials and chemicals. This is a demand-driven sector and these companies are beholden to commodities prices and high output costs. Those factors do not mitigate the power of this sector from an investment standpoint. However, the basic materials sector is not a defensive group and this sector needs not only positive market sentiment to perform well, but the broader economy needs to be strong for these companies to generate robust returns.
This is another industry group that is extremely sensitive to fluctuations in the business cycle. Capital goods makers are essentially industrial companies that are manufacturing-intensive. These companies make everything from aerospace products to industrial tools and many products in between. Capital goods stocks perform well when the economy is expanding or booming. High GDP growth and low unemployment are positive signs for this group.
Conglomerates are companies that have their hands in a variety of different businesses, making it hard to pinpoint exactly which sector the company is a member of. That is not a negative trait. If anything, it can work in favor of investors because if one business line is weak for conglomerate, another one of the company's business units can pick up the slack. Conglomerates are usually viewed as value stocks and many have significant exposure to other sectors such as financial services, capital goods and energy.
Consumer Cyclical and Non-Cyclical
Consumer cyclicals are just that: Cyclical in nature and very beholden to the whims of the business cycle. The sector is also known as consumer discretionary, meaning that consumers use discretionary income to purchase items like apparel, automobiles, jewelry and televisions. This is the epitome of a sector that performs well in good economic times and poorly during sluggish economies.
On the other hand, consumer staples companies produce goods that consumers need to buy. Items like food, household products like laundry detergent and personal items like deodorant and razors are all considered consumer staples. This is viewed as a defensive sector. As such, consumer staples stocks typically don't fall as much as the broader market in a bear market, but in a true bull market, staples stocks also don't rise as much as stocks from riskier industries.
Foreign Currency – Forex
A lot of investors don't realize that the currency market is by far the largest financial market in the world. Everyday the world's currency markets trade more in dollar terms than all of the world's bond and stock markets COMBINED. Having some currency exposure in your portfolio is a good thing, particularly to protect your investments from rising inflation or a weakening U.S. dollar. Currency ETFs help investors accomplish those objectives without the risk of trading currency in the spot market.
The energy sector is one of the largest and most dynamic industry groups in the world. This group is more than just big oil companies and has evolved to include many sub-sectors such as wind, solar and other alternative energy producers. Coal producers and oil services providers are also part of the energy sector.
Obviously, oil companies generally perform well when oil prices are high, but alternative energy stocks have shown an ability to generate solid returns when oil prices soar because high oil prices renew calls for more investments in alternative energy sources. This industry moves with supply and demand trends as well as price action in a volatile commodity, but the large integrated oil companies are somewhat defensive in nature and offer strong dividends.
This sector is home to retail banks, brokers, asset management firms, credit card issuers and insurance providers and is also the largest industry group in the S&P 500, accounting for about 20% of the index's market capitalization.
Given that large weight in the most important U.S. stock index, financials are one of the most widely followed sectors. These companies are sensitive to strength or weakness in the broader economy, but they perform well when the yield curve is steep, allowing banks to borrow money from the government at low rates and then loan that money out to borrowers at higher rates. Financials have traditionally been good dividend payers, though that scenario has changed in recent years.
The healthcare sector encompasses pharmaceuticals providers, makers of medical devices and providers of health insurance, making this a defensive group, but at the same time, healthcare stocks are vulnerable to political risk. Biotech stocks would also be considered healthcare names and this group can offer exponential growth opportunities in comparison to big pharmaceuticals companies, which are generally value plays.
Precious Metals – including Gold, Silver, and Platinum
Thanks to the evolution of ETFs, investors can access the precious metals sector in two different ways: By owning commodities like gold, silver, palladium and platinum directly or by owning the companies that mine for these metals. Given that miners face high production costs, those stocks do not always move in unison with prices in the underlying commodities and it is possible that the metals themselves can move higher when the broader market slumps given the safe-haven status afforded to gold.
Gold is the most heavily traded metal in this group, but all precious metals offer potent investment potential. In fact, it is worth noting that gold is the only member of this group that does NOT have industrial uses.
Real Estate Services
Investors can access real estate via the equity markets by owning real estate investment trusts, which generally perform well when the broader economy is expanding. A slow or contracting economy leads to a glut of available commercial real estate and those are the times to avoid REITs, but when the economy lends a hand to a booming real estate market, real estate equities are a compelling investment because many pay enormous dividends with robust yields.
While the technology industry itself has matured, this is still a sector that is prized more for its growth potential than it is as a value proposition. Technology is considered a market leadership group as many of the largest companies in the U.S. are now tech companies. A few tech names do pay decent dividends, but most investors in this sector are looking for capital appreciation, making the group an ideal play in a strongly bullish market, but one to avoid in bear markets.
Perhaps no sector provides an accurate temperature check on the health of the broader economy the way the transportation group does. Home to airlines, shipping firms and railroad operators, investors can glean valuable insight about the economy's health by tracking transportation stocks.
These stocks are intimately tied to the whims of the business cycle and this group does confirm both bullish and bearish moves in other sectors of the market. The best time to be invested in transportation stocks is immediately following a trough in the business cycle, right before the economy starts to turn for the better.
Of all the sectors that can be considered defensive, utilities may be the king of that group. Utilities have predictable earnings and revenue streams and usually offer solid dividends, making them appealing to conservative investors. These stocks usually perform well when interest rates are low, which allows utilities to borrow money for capital projects at reasonable rates. Given the sector's clearly defined defensive posture, investing in this group works best when riskier sectors like basic materials, energy or technology have fallen out of favor.
Investing in Specific Sectors and Areas
There are many ways to invest in specific sectors and market areas. One of the most efficient ways to do this style of investing is by using Exchange Traded Funds (ETFs). There are also ETFs focused on virtually every sector as well as on commodity plays, foreign currencies and fixed income.
Investors seeking to learn more about investment opportunities in specific sectors and market areas should click below:
The appeal of ETFs is astounding as there really is something for every type of investor in the ETF universe. From emerging markets to dividend ETFs; to bond funds, to ETFs that track crude oil and gold; there is an ETF for everyone from active traders to conservative investors. But with 800+ ETFs currently available, how can you be assured that you’re holding the right ETFs for current market conditions? This is where the ETF Profit Report becomes an invaluable tool in your investment arsenal. View our latest ETF research.