When you hear the term market sectors or market rotation, what are they talking about? What is a sector and how does that effect my portfolio?
The market is divided into three broad categories. 1). Defensive stocks: companies that should do well in good times and bad. They are the essentials of life. 2). Growth companies: ones that are more volatile with great opportunity for gains and losses. 3). Cyclical companies: ones that literally cycle in and out of favor, generally based on the underlying economy.
Within each broad category are sectors, companies whose stock is going to trend similarly with good and bad news.
The Defensive sector includes consumer staples (grocery stores, chocolate, washers and dryers). Also included is health care (hospitals, pharma, and research companies). Utilities, (heat, water, and lights) are a part of this sector as well. These are generally, as a category, older companies that tend to pay dividends instead of using all profits for growth.
The Growth sector includes communications companies such as phone companies and social media. Energy companies (like big oil and gas as well as pipelines and refineries). Industrial companies are generally big machinery, harvesters, trucks for delivery (both local and across countries). The growth sector also includes technology, computers, research, and software. These are, for the most part, companies that put all their profits back into the company to stimulate further growth.
The Cyclical sector includes basic materials, such as building materials, carpeting, paint, and roofing materials. Consumer cyclical would be companies that provide products that people would spend money on in good times like gym memberships, exercise clothing and equipment, specialty food items, and travel & leisure. More examples of the cyclical sector include financial services, banks, investment companies, lending agents, insurance companies. real estate builders, real estate investment trusts (REIT), and shopping centers. These can be new or old companies, and they can be growth or dividend paying companies. Generally, this sector does better when people have more cash to spend as well as the stock does better in a strong economy.
The market will go through periods where sectors will go up or down almost sequentially as good news and bad news hits the market. This is a time when we are seeing sector rotation.
Sectors of the market will often react together to good and bad news and almost always the entire market will react together to shocks in the market. If a good shock, we see the strong upward trend and if a bad shock (think Covid 19), we see a strong negative market reaction. When bad news is expected but it is not as bad as estimated, the sector that would be affected, generally will show little or no reaction. However, if the bad news is worse than expected, there would be a negative response. On the good news side, this is not always the case. If an expectation is for a positive report, the market will see that as okay. However, if the estimate misses by the smallest of margins, generally the company (and often the sector), will show a negative effect. If the outcome is strongly to the upside, then the company may increase enough to pull the entire sector up.
We are currently in the middle of the 2nd quarter reporting period, you may want to look at a finance channel and listen to the outcome reports to see the effect on the company stock, the industry, and the sector. Most companies are expecting negative reports so see how a better than expected report move the market, sector, industry, and stock.