The stock market classifies stocks in many ways, but one of the most useful is by type of business. Companies in similar industries can be grouped together for the purpose of making like comparisons (apples to apples). Most analysts and financial media call these groupings “sectors,” and you will often read or hear about them in terms of how well certain stock sectors did during a past quarter or how well they might perform in the near future.
There are a few versions of the list of sectors, but for the most part, investors and market players agree on a set standard. One of the most common systems of classification breaks the market into 11 different sectors. Here, we'll cover the many sectors and offer a few examples of how they are used, so you can use this knowledge in making your own stock investment choices.
- All publicly traded stocks are categorized into sectors, and sometimes subsectors, based on their companies' industries.
- Defensive sector stocks tend to stay stable during market fluctuations because they consist of consumer necessities such as food and utilities.
- Cyclical sector stock prices follow patterns in the market and can be volatile to other economic forces.
- Analyzing stocks by sector can provide deeper insight into their performance.
The Main Sectors
Almost every company whose stock is traded in the market falls into one of the 11 sectors defined by the Global Industry Classification Standard (GICS). In order from largest to smallest, they are:
- Information technology
- Health care
- Consumer discretionary
- Communication services
- Consumer staples
- Real estate
Each contains many types of businesses and so, most of the sectors can be broken down into subsectors. The consumer discretionary sector, for example, includes all manner of businesses that produce retail and luxury items that are not crucial for daily living, such as high-end clothing, fine dining, and more. The health care sector can also be broken into many subsectors, such as standard care services, drug manufacturing, medical devices, health data software, and more. Many of these industries have very little in common with one another in how they work, yet their stock prices may mirror the state of market in similar ways.
Two of the 11 main sectors are thought of as “defensive,” while the rest are called “cyclical.” They are named as such based on how their stocks respond to market conditions.
It may come as no surprise that the tech sector has seen a boom over the last couple decades, but it may soon have competition. Sector growth responds to events and changes that happen at a global level. With a growing social eye to climate change, and as the world comes out of the market dip of 2020, some experts are watching the energy and finance sectors.
The Defensive Sectors
The two defensive sectors include utilities and consumer staples. Both are mostly stable in the grand scheme of the market, meaning they don’t suffer as much as other sectors might in a market downturn. The reason is simple: Even in tough times, people don’t fully stop using heat or lights, nor do they stop eating. These types of stocks can provide balance to portfolios and a means to protect against a falling market.
On the other hand, for all of their claim to safety, defensive stocks usually fail to climb with a rising market, for the opposite reasons that they provide protection in a falling market: In good times, people don’t use much extra energy, nor do they tend to consume a great deal more food.
Defensive stocks do what the name implies as long as they belong to solid companies. These shares can give you a cushion for a soft landing in a falling market.
Cyclical Stock Sectors
Cyclical stocks cover every sector other than the two touched on above, and they tend to react to a wide range of market conditions that can send them up or down. These sectors respond to certain trends or triggers and can move independently from each other; when one sector goes up, another may be going down. What they have in common is the way their stock may rise or fall with market patterns. That goes for each of the nine sectors and their subsectors as well.
When you drill down into the details of how the businesses actually operate, it makes sense that stocks in the cyclical sectors tend to move up and down in relation to business cycles and other influences. For example, the basic materials sector includes those items used in making other goods, such as lumber. When the housing market is active, the stock of lumber companies tends to rise. In a market dealing with high interest rates, home sales might be down. It follows that this situation would put a damper on home building as well, which in turn would reduce the demand for lumber. Soon, the industry's stocks' prices would fall.
Although it may vary from year to year, the energy sector is often among the most volatile, because it is based in oil, coal, gas, and renewable energies, which are in constant flux. Prices can be subject to change due to such things as oil spills, international conflict, politics, natural disasters, and other such forces beyond control.
How To Use This Knowledge
Stock sectors can be thought of as helpful tools to sort and compare stocks. There are many digests and firms that publish statistics by sector, so you should have no problem finding data. Try not to get hung up on using just one set of sectors, though. Morningstar, for example, uses a slightly different set of sectors from those named by the GISC; for the most part, they tell the same story, but each may have something unique to offer. The most crucial piece of advice is to always compare stocks within a sector.
Sector funds, as the name implies, are types of funds that contain stocks from a range of companies within a single sector. They come in many forms, such as mutual funds or EFTs. Sector funds can be useful for people who want to focus their money in a certain industry while still keeping their investments diverse.
Analyzing stocks by sector has become a common practice, since sector information makes it easy to compare how your currently held stock, or a stock you may want to buy, is doing relative to those of other companies in the same sector.
Sector analysis can highlight the fact that, for example, all of the other stocks are up by 9% and yours is down by 5%, and you would want to find out what's driving the difference. Likewise, if the numbers are reversed, you would want to know why your stock is doing so much better than others in the same sector. Perhaps a business has changed its business model, hired a new CEO, gained a major client, or made some other change that has caused its success. You'll want to determine whether the rise is short term or whether it might be the new normal.
In sum, when you compare stocks within a sector, you can access a deeper level of insight into how your stock performs or might perform.