Dividing up the market
With thousands of companies in the stock market, identifying large trends in the economy can seem like an insurmountable task. Grouping similar companies together allow us to simplify macroeconomic events and interpret meaning from these events with a single chart of the S&P 500. The market is broken down into 10 sectors based on the product or service provided by each company. These sectors are broken down even further into more detailed subsections. While Microsoft and Apple both fall within the technology sector, their core businesses are focused on slightly different things. As a result, Microsoft is subdivided into software and Apple falls under consumer electronics.
- Technology: hardware, software, semiconductors
- Financial: banks, brokerages
- Communication services: telecom, tv, social media
- Healthcare: pharmaceuticals, healthcare equipment and services
- Consumer cyclical: automotive, housing, entertainment, retail
- Consumer defensive: food, beverages, household and personal products, packaging, tobacco
- Industrials: heavy equipment, transportation, construction
- Energy: coal, oil, gas
- Real estate: new real estate, real estate management, real estate trusts
- Utilities: water, electricity (including green energy), natural gas
- Basic materials: chemicals, construction materials, mining
Analyzing the market
The market as a whole could be up on any given day, an individual sector could be struggling based on factors specific to that industry. During the 2008 Financial Crisis, banks were getting hit hard as a result of increased interest rates that caused subprime mortgages to go into default. A wave of people stopped paying their loans causing some banks to even go bankrupt. The whole market dropped but the financial sector was down significantly more than other sectors. If you wake up to the market in the red, you can pull up the map to quickly identify which sector is underperforming. If the financial sector block is bright red, there might have been a new federal monetary policy issued or interest rates might have changed.
Investment strategies can even be built around these sectors. Identifying a sector you believe will outperform the market based on economic trends can help you narrow down companies to invest in. For example, in a high inflation environment investors typically turn to consumer defensive/consumer staples. When people's buying power is decreased they will continue to buy food and other necessities while forgoing luxuries like entertainment (communication services).