Sectors help categorize stocks
A sector is a high-level grouping of companies based on business activities. While there are many ways to define sectors, a popular one is known as the Global Industry Classification Standard (GICS), developed by Morgan Stanley Capital International and Standard & Poor’s.
There are 11 different market sectors
GICS groups companies by their various business activities into 11 sectors. These include: Communication Services, Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Information Technology, Materials, Real Estate, and Utilities.
Within these sectors, companies are further grouped into Industry Groups, Industries and Sub-Industries. In doing so, companies with similar activities or business models can be easily discovered and compared.
Sectors make things easier for investors
Sectors allow investors to invest in different parts of the stock market easily. The stocks of companies in different sectors can behave quite differently from one another. For instance, Information Technology companies (i.e., Facebook, Amazon, and Google) have experienced significant growth due to trends in the internet and consumer technology. Utilities companies (i.e., Duke Energy, Engie, and National Grid), on the other hand, have been popular due to their relative safety and ability to generate income via stable and consistent dividends. Investors often look to sectors when investing based on market cycle, and may choose to invest in companies in one particular sector based on different market conditions and historical behavioral trends. For example, in a volatile economy investors may flee to the stability of those Utility Company sector stocks described above.
Cyclical vs. defensive sectors
Investors often like to think about sectors in terms of those that are cyclical, which are the sectors that perform well if the economy does well, and those that are defensive, which are the sectors that provide some measure of safety, especially when markets are volatile. The Consumer Discretionary sector, which includes companies that produce large, expensive consumer goods such as washing machines, is more cyclical than Consumer Staples, whose companies produce basic necessities such as toilet paper. After all, we need toilet paper and other staples regardless of market conditions, right? Investors generally are attracted to cyclical sectors during times of economic growth, and are more attracted to defensive sectors when they suspect an economic downturn or recession.
Sectors may help you reach your investment goals
Ultimately, thinking in terms of sectors is a tool investors can use to construct portfolios that makes the most sense for their financial goals. There are even a wide array of mutual funds and exchange-traded funds (ETFs)) that track individual sectors, which can simply the investment process. Additionally broad market ETFs, such as those that track the S&P 500 or other market-wide indexes, invest across sectors and may often be sector-weighted. By understanding each sector’s stock market behavior, investors can better tailor their stock market allocations beyond what a broader index might provide in order to more finely tune their investment strategies.