The world of finance and investments is notorious for its extensive use of jargon. With a goal to enhance financial literacy and make the world of money more transparent, we have our “monthly jargon” articles that focus on debunking financial terms that are often used sans explanation. The beginning of the year marks a great time to revisit your risk profile and allocations to ensure these components are aligned. In line with that theme, this month, we are breaking down the “market sectors” of the S&P 500 Index, one of the main market indexes that comprises 500 of the largest publicly-traded companies in the U.S., that can help you build a healthy, well-balanced portfolio.
What is a “Market Sector”?
A market sector is a slice of the stock market that represents a certain part of the economy or of an industry. In total, there are eleven sectors in the stock market, and each has its own characteristics. Think of each sector as an umbrella under which certain industries are grouped and representing those industries are the companies in those industries that trade on the stock market. In no particular order, let’s break them down one by one.
- Consumer discretionary – This sector involves discretionary consumer products that are luxury items or services. Such products offered by companies in this sector include jewelry, cars, sporting goods, electronic devices, and experiences such as hotels, vacations, and high-end dining. Some examples of companies in this sector include Amazon.com Inc., Starbucks Corporation, and Tesla Inc.
- Communication services – This sector represents companies that aim to keep people connected, including phone plan and internet providers, media, and entertainment. A few examples of companies in this division comprise Netflix Inc., Facebook Inc., and Alphabet (Google’s parent company).
- Industrials – This division includes a fairly wide range of companies, including certain manufacturers, delivery services, airlines, and railroads. This sector’s umbrella spans far and comprises 14 industries. A few commonly recognized companies within this sector are Southwest Airlines, FedEx Corporation, Boeing Company, and American Airlines Group.
- Consumer staples – Think of this sector as the companies that provide life’s necessities, including household product providers, supermarket chains, food and beverage companies, and personal product providers. Companies in these sector offer products that we regularly see in grocery stores, including supermarket stores themselves. Recognizable names from this sector include Costco Wholesale, Kellogg Company, Procter & Gamble Company, and Coca-Cola Company.
- Energy – This sector comprises all companies involved in the oil, gas, and fuels industries, including companies that locate, drill, and extract these commodities, companies that refine these materials, and companies that manufacture or provide equipment involved in these processes. Examples of companies in this sector include Exxon Mobil Corporation, Kinder Morgan, and Chevron Corporation.
- Financials – The financials sector is made up of all companies involved in finance, investing, and money movement or storage. Companies within this sector tend to be mature, well-established firms that are considered relatively stable investments. Such companies include banks, credit unions, credit card issuers, and insurance companies, including Bank of America Corporation, Goldman Sachs Group, and American Express Company.
- Health Care – This sector comprises pharmaceutical companies, medical supply companies, and companies that provide scientific-based services and operations targeted towards advancing human health. Companies in this sector include Pfizer Inc., Johnson & Johnson, and Cigna Corporation.
- Information technology – Also referred to as the IT sector, this division consists of companies that make or distribute technological services or products, including computers and operating systems. Internet companies are included in this sector. Examples of companies within this sector include Apple Inc., Cisco Systems Inc., Intel Corporation, and Microsoft Corporation. This sector has seen a lot of change in recent years due to the rapid rise and development of technology-based companies.
- Utilities – Companies within this division generate and provide water, gas, and electricity to households and buildings. A common focus for utility companies in recent years is the development of renewable energy resources. Examples of companies in this sector include Exelon Corporation, Nextera Energy, and Dominion Resources.
- Real estate – This is the newest sector to be recognized and added to the list. Real estate was officially recognized as its own market sector in 2016; previously, real estate investments had simply been grouped in with the financial sector. Companies within this sector include realtors, real estate investment trusts (REITs), and real estate companies like American Tower Corporation, Equity Residential, and Alexandria Real Estate Equities.
- Materials – The materials sector involves companies that provide raw materials like mining and forestry companies; however, there are several packaging and container companies included in this sector as well. Several examples of materials companies are Sherwin-Williams Company, Vulcan Materials Company, and Dow Inc.
Why Sectors?
These eleven sectors exist to help investors determine the allocation of funds within their portfolios. Sector investing revolves around market sectors, offering targeted exposure to equities that represent companies in specific segments of the economy. Diversifying your portfolio with methodical exposure to these sectors helps investors pursue growth, diversify portfolios, and manage risks. Investors can leverage the sectors to isolate stocks of specific interest or to build a diversified portfolio. Sector-based investing and economic cycles go hand in hand, allowing a way for investors to adjust their exposures to certain sectors depending on the business, also known as the economic, cycle at hand. The various sectors tend to be impacted differently by phases of the business cycle and tend to perform better in certain phases.
For example, these sectors are all unique in that they tend to respond to events in the market differently. Maintaining a diversified portfolio helps to ensure you are not too heavily weighted or invested in one sector in the event that sector takes a hard hit, like the airlines industry in the industrials sector did amid the COVID-19 pandemic. On the opposite end of the spectrum, the consumer discretionary and industrial sectors tend to outperform in the early stages of a business cycle, during a rebound, for example, like the one we have witnessed as the economy rebuilds and recovers amid the coronavirus crisis.
Final Points
Overall, knowing and understanding how these sectors work can guide the selection of stocks, mutual funds, exchange-traded funds (ETFs), and other types of investments to help investors build a portfolio that can weather unpredictable market behavior. Sectors are an important part of investment research, and examining how certain sectors may play off each other helps investors and portfolio managers build out portfolios and funds, respectively, that aim to produce returns with proper risk exposure. Diversification, involving investment across a variety of sectors, is an invaluable component of a strong investment strategy. By diversifying across sectors, you are spreading out risk and effectively preparing your portfolio to weather potential underperformance by a certain sector that can be balanced out by a strong performance from a complementary sector.
Read the full article here
