Stock Sectors 101
Investors experienced unusual gains over the past decade or so in the S&P 500. The S&P 500 is especially popular because it represents ownership in the 500 largest publicly-traded companies in the United States. That gives investors exposure to a very broad range of companies and industries.
But there are times when specific investment sectors outperform the general market. This tends to be particularly true during times of stagnation or decline in the general stock market. But sector funds can also outperform the general market if the industries they represent are outperforming the general economy.
Two common examples are technology and health care. They're both necessary to the general economy and are on the cutting edge of technological advancement. So they tend to draw an outsized share of investor capital. That causes prices of stocks in these sectors to rise faster than the general market, often ignoring the state of the economy and the financial markets.
The S&P 500 may still be the index of choice among investors at the moment. But with the market showing signs of stagnation and facing predictions of decline, you owe it to yourself to investigate different stock sectors that have the potential to outperform the general market in what could be a very different financial environment than we've seen in the past decade. Diversify!
10 of the most popular stock sectors are listed below. You can invest in any of these sectors through sector funds. These can be either exchange-traded funds (ETFs) tied to a widely recognized index or actively managed mutual funds that try to outperform the market sector.
This is one of the most popular stock sectors in the investment world. That's because it tends to perform well regardless of what's happening in the economy or the financial markets. Part of that is that demand for health care tends to remain constant regardless of what's happening in the economy or the financial markets.
But an equally significant reason is that revenues in the sector have shown a very steady, long-term upswing. Because of the life-enhancing and even lifesaving capabilities the industry provides, public willingness to expand funding to the industry often seems unlimited.
The sector includes hospitals and other healthcare providers, as well as makers of specialty medical devices and equipment. It also includes drug companies and biotech companies. Much like the technology sector, this is an industry that produces steady improvements in technological capabilities, further increasing revenues to the industry.
As a sector, health care comes very close to being an all-weather investment. It does well in booming economies, recessions, stock market bubbles and crashes. However, with the latter, the healthcare sector can experience something of a sympathy decline with the general market.
Examples of healthcare sector funds include Vanguard Health Care ETF (VHT) and iShares Global Healthcare ETF (IXJ).
Much like health care, the technology sector comes extremely close to being an all-weather investment group. This has been increasingly true in recent decades, as the rate of technological advancement seems to be increasing. Technology stocks tend to outperform the general market during market advances while often resisting declines in a market fall (other than the dot-com bust, when the carnage was specific to the tech industry).
Technology stocks tend to be well represented in the S&P 500. But add a position in the technology sector if you're looking to supercharge your portfolio.
The sector includes companies that are involved in information technology (IT), practically anything related to the internet, and the many high-tech devices that are spreading throughout the world. But it also includes computer hardware, software and semiconductors.
Long term, this is an outstanding sector.
Examples of technology sector funds include Vanguard Information Technology ETF (VGT) and iShares Evolved U.S. Technology ETF (IETC).
This is another diverse sector that includes multiple industries. For example, it includes publicly traded banks, insurance companies, investment brokerages and financial services companies like PayPal. It's another sector that's both well represented in the S&P 500 and closely tied to the general performance of the economy.
That doesn't mean the sector doesn't have value. In a rising economy, particularly one coming out of a recession, demand for financial services, particularly loans, is brisk. Financials can outperform the general economy during this phase of the economic cycle.
However, it's generally a sector to be avoided when the economy is sinking. One of the telltale signs of a declining economy is erosion in loan performance. This hurts banks and other lenders. But investment brokers and insurance companies can also be hurt due to declining investment prices and a reduction in investor activity. For example, during the financial crisis of 2008, the financial sector performed especially poorly.
Examples of financials sector funds include Fidelity MSCI Financials Index ETF (FNCL) and Invesco KBW High Dividend Yield Financial ETF (KBWD).
The natural resource sector is sometimes referred to as “materials” or “raw materials.” These are companies engaged in the business of providing natural resources to the economy. This includes companies engaged in mining, logging and lumber production. It could even include energy production, though that's a sector all its own.
The sector also includes stocks of companies engaged in refining the raw materials. This includes lumber companies, steel companies, companies that refine other types of metal (like copper and aluminum) and even chemical companies.
The sector tends to do best when the economy is coming out of a recession and is in a fast-growth mode. That's when demand for natural resources accelerates, increasing revenues and profits to the companies engaged in providing them.
The sector can be a play on inflation. Since these companies are engaged in producing primary products, they often benefit from rising prices. Another potential scenario is when certain raw materials are in short supply, perhaps because of a disruption in supply from an unstable region of the world.
Examples of natural resources sector funds include SPDR S&P North American Natural Resources ETF (NANR) and SPDR S&P Global Natural Resources ETF (GNR).
When we think of energy we think mostly of oil and natural gas. Companies engaged in the production of oil and gas are certainly well represented in the energy sector. But the sector also includes companies involved in coal and uranium. It can even include alternative energy, such as solar and wind power (though these are subsectors all their own).
But beyond production of raw energy, the energy sector also includes companies involved in refining energy, as well as providing products and services to the energy industry. This includes companies that produce and service energy pipelines or provide very specific equipment necessary for the industry.
The energy sector tends to do well when the economy is in recovery or solid growth. Economic growth requires energy, which favors this sector. The industry can also do very well during times of energy shortages. Since much of the world's raw energy is produced in areas of the world that are unstable, the potential for a reduction in international supply is not uncommon. During these times, the price of energy can spike, increasing profits and revenue to companies in the industry.
But the industry as a whole tends to do poorly when energy prices are falling. This can happen due to either oversupply or a weakening of the general economy. For this reason, the energy sector is generally not a good play when the economy is slowing or in a recession.
Examples of energy sector funds include Vanguard Energy ETF (VDE) and iShares US Oil & Gas Exploration & Production (IEO).
This is another very broad sector. Industrials encompasses many different industries. In the most general sense, industrials are about companies engaged in the production of capital goods. These include industrial machinery, electrical equipment, construction equipment, machine tools and robots. But it also includes more specific manufactured goods, such as automobiles, aircraft, ships and computers.
As you might expect, this sector has a large number of subsectors. For example, you can choose to invest in just the auto industry or just appliances.
Like most sectors, industrials tend to perform best when the economy is in growth mode. However, since these are some of the largest companies in the country, industrials are well represented among the S&P 500. This makes it unlikely the sector will outperform the general market.
Conversely, this is a sector best avoided or even reduced if the economy is in decline. Demand for manufactured goods tends to fall with a declining economy.
Examples of funds in this sector include Vanguard Industrial ETF (VIS) and iShares U.S. Industrials ETF (IYJ).
This sector includes companies engaged in the sale of real estate, as well as the construction of both residential and commercial buildings. It's yet another sector that tends to do particularly well during times of economic expansion. It can also perform extremely well as the economy is coming out of a recession, as demand for housing, retail space, office buildings and other units increases. And it can outperform the general market if real estate is doing particularly well in a growing economy.
But like so many sectors, it can underperform the general market during an economic decline, such as a recession. It's also possible for certain areas of the country to perform poorly in any given time.
An alternative to real estate sector funds is real estate investment trusts or REITs. These are like mutual funds but for real estate. They usually comprise commercial properties. This includes office buildings, retail space, warehouses, hotels, medical facilities, and large apartment complexes. The advantage of a REIT is that it holds existing and often mature properties that provide solid cash flows. As a result, they typically pay very high dividends.
Examples of real estate sector funds include Vanguard Real Estate Index Investor (VGSIX) and Schwab US REIT ETF (SCHH).
If you can say such a thing about any sector, utilities are probably as close to boring as it gets. Companies in the sector are usually well-established businesses that provide electricity, gas for heating, sanitation and water purification. Because everyone needs these services, the industry tends to be very predictable. There's little in the way of technological innovation or fast growth. Revenues remain relatively stable even when the economy is in a recession.
Utility companies are well known for paying dividends. That's what also contributes to the stability of the sector. But the sector has its downsides. Because the sector is so reliant on dividend yields, it also tends to be interest-rate sensitive. Much like bonds, when interest rates rise, the stock price of utility companies decline. In that way, utilities can function more like bonds than stocks.
Utilities tend to be a good play in recessions, as long as the cycle isn't accompanied by rising interest rates. And it may get something of a bump if energy consumption increases significantly in response to a rising economy.
Examples of utilities sector funds include Vanguard Utilities ETF (VPU) and Fidelity MSCI Utilities ETF (FUTY).
These come in two different general categories, consumer discretionary and consumer staples.
Consumer discretionary is exactly what the name implies. They're the kind of consumer goods we buy when we have extra money. This includes automobiles, restaurants, travel, retail, and apparel. We may or may not need any of these items, but sooner or later we all buy them. And as you might expect, people buy more of them when the economy is strong, and jobs are plentiful. This sector can be an excellent play on a growing economy.
We buy consumer staples (consumer goods) all the time, regardless of the state of the economy. Companies in this sector include food and grocery stores, beverages, personal products, and common household goods. Walmart and Coca-Cola are examples of companies found in this sector. Everyone buys their products pretty much all the time.
For this reason, consumer staples are considered a defensive sector. It can be a good sector to invest in when the economy is struggling because their revenues and profits are relatively unaffected by the state of the economy.
Examples of funds in this sector include VanEck Vectors Retail ETF (RTH) and Vanguard Consumer Staples ETF (VDC).
This sector is mostly related to gold. It's a highly speculative sector because gold tends to be a static asset in most economic environments. But it has a history of performing well when most other asset classes are sinking. For that reason, it's mostly seen as a countercyclical investment sector.
Gold funds typically invest in gold mining companies. They don't hold large amounts of gold bullion, though some may take a small position in the metal itself. They're mainly a play on higher gold prices and the higher revenues and profits that will produce for gold mining companies. For that reason, gold stocks often outperform gold itself.
Examples of precious metals sector funds include VanEck International Investors Gold A (INIVX) and Fidelity Advisor® Gold A (FGDAX).
Final Thoughts: Stock Sectors 101
Investors in recent years have mostly invested in the general market, largely through S&P 500 index funds. That's certainly the right strategy in the rising market we've been enjoying. But if you're looking to enhance your returns or to better weather a downturn in either the economy or the financial markets, it'll help to add certain stock sectors to your portfolio. They can help to improve your performance during rising markets and cushion the fall during declines.
A. Yes. Capital squandered on fossil fuel industries could be far better deployed on stocks in sectors that are growing: information technology, discretionary consumer, financials, health care, industrials, utilities, and real estate. Within the energy sector, investments concentrated in energy-efficiency technologies, renewable energy, and electric vehicles are producing solid returns and offering growth opportunities now.