Investors are bombarded with news about how well(and poorly) individual companies perform and howwell groups of companies that share similar businesscharacteristics might perform given certain economicenvironments.
Unfortunately, many use the terms “sector” and“industry” incorrectly and it’s important to understandthe differences between the two, because what manyrefer to as “an industry” is actually “a sector.” While itmight sound like splitting hairs, it’s not, as financialadvisors are more apt to focus on sectors as anadditional diversification tool.
Creating categorizations of companies
The global economies and by extension each of thestock markets within and all publicly tradedcompanies, are essentially organized into hierarchicallevels:
- At the highest level we find 11 groups of similar companies called sectors;
- Below the 11 sectors we find 24 industry groups;
- Below the 24 industry groups we find 69 industries; and
- Below the 69 industries, we find 158 subindustries.
As we move down the hierarchical pyramid, thecharacteristics of the companies within thegroupings become tighter. In other words, twocompanies categorized within the same sub-industryshare more economic characteristics versus twocompanies categorized in the same sector.
Sectors can help diversification
Financial advisors examine historical sectorperformance and analyze how companies areorganized into different industries because both areimportant tools when building diversified portfolios forclients.
The reason is that because over every single timeperiod, sector performance is driven largely by factorsone would expect, such as the overall state of theeconomy, underlying corporate earnings, current andpredicted interest rates, and inflation, among otherfactors. And financial advisors know that reviewingsector performance on a monthly, quarterly, semiannuallyand yearly basis proves one thing:
- Sectors do not move in lock-step with one another and will often provide very divergent returns for investors – depending on timing and the current economic climate
The S&P 500
The S&P 500, sometimes simply called the S&P, is astock market index that represents the collectiveperformance of 500 publicly traded, large-capcompanies in the U.S. (ok, technically there are 505,but let’s talk about that another time). Representingabout 80% of the U.S. equity market, the S&P 500 isone of the most often-cited proxies for the U.S. stockmarket.
Introduced in 1957, the S&P 500 is maintained byS&P Global and in order for a company to be includedin the S&P 500, it must meet certain criteria,including:
- Be in the U.S. with an unadjusted market cap of at least $8.2 billion
- At least 50% of its stock must be available to the public
- It must file a 10-K annual report
- Have at least four consecutive quarters of positive earnings
- Be listed on the New York Stock Exchange, NASDAQ, Investors Exchange or BATS Global Markets
The 11 S&P 500 sectors
Each of the companies within the S&P 500 iscategorized into one of 11 sectors and for most ofthem, the name of the sector says it all:
Information Technology sector contains companiesthat develop or distribute technological items orservices
Health Care sector contains companies that developor distribute medical supplies and pharmaceuticals
Financials sector contains companies involved infinance and investing
Consumer Discretionary sector contains companiesthat develop or distribute products that are consideredluxury items (not needed to survive).
Communication Services sector containscompanies that allow us to communicate – internetand phone providers, media, and entertainmentcompanies
Industrials sector contains a broad swath ofcompanies, including airlines, construction andrailroad companies
Consumer Staples sector contains companies thatare needed to live (the opposite of consumerdiscretionary). Think food and beverage companies
Energy sector contains companies that are in the oiland gas business in some way
Utilities sector contains companies that provideelectricity, water and natural gas to consumers andbusinesses
Real Estate sector contains Real Estate InvestmentTrusts, realtors, home-builders and similar companies
Materials sector contains companies that provide rawmaterials, like copper, zinc and paper
The percentage of each within the S&P
The percentages of each sector within the S&P500 as of the end of June is as follows:
- Information Technology: 24.4%
- Health Care: 14%
- Financials: 12.2%
- Communication Services: 10.7%
- Consumer Discretionary: 9.9%
- Industrials: 8.9%
- Consumer Staples: 7.2%
- Energy: 3.6%
- Utilities: 3.5%
- Real Estate: 3.1%
- Materials: 2.5%
Why sectors matter
As evidenced in the first six months of 2020, therelative performance of each sector tends to rotate asthe overall economy shifts from one business cycle tothe next. But this is not a phenomenon that is new –sectors have always rotated from performanceleaders to performance laggards based on structuralshifts in the economy.
For example, some sectors are considered moresensitive to interest rate movements – financials, realestate and consumer discretionary.
Other sectors are considered more economicallysensitive, meaning they do better when moving fromrecession to recovery – industrials and informationtechnology for example.
Some sectors are considered more defensive, likeutilities and health care.
Sector performance in 2020
The overall trend for sector performance in 2020 hasbeen mixed, as performance leaders and laggardshave rotated all year.
You might remember, for example, that in the firstquarter of 2020, all 11 S&P 500 sectors werenegative, whereas April saw all of them positive, themonth of May saw most of them positive and Junesaw less than half of them positive.
Reviewing the sector returns for the second quarterand YTD through June 30, 2020, we saw that:
- Every single one of the 11 S&P 500 sectors was positive for the second quarter of 2020
- The Utilities sector was the worst performer for the second quarter as it barely crept into positive territory
- The differences between the best performing and worst performing sectors in Q2 were dramatic, with three sectors (Consumer Discretionary, Information Technology and Energy) up more than 25x the Utilities sector
- On a YTD basis, the differences between the best and worst performing sectors is just as dramatic, with a difference of over 50% as Information Technology sector is up over 14% YTD and Energy is down a whopping 37%
Here are the sector returns for shorter time periodsthrough the end of June 30, 2020:
Knowing which sectors have historically performedwell during certain market environments is just asimportant as knowing which ones have performedpoorly in certain environments.
Your Synovus financial advisor can help you better understand how and when to use sectors within your overall asset allocation. Call us at 1-888-SYNOVUS (1-888-796-6887) to discuss.
