What are Sector Strategies?
Sector strategies are equity investment approaches that invest by industry, or sector. Often, companies in the same sector have similar characteristics and risk profiles, which can cause their stock prices to move together in response to prevailing economic conditions. At the same time, in the same conditions, companies in other sectors may be affected quite differently.
Who Should Use Sector Strategies?
Sector strategies may appeal to investors looking to outperform the market by acting on their views about where the economy is heading, and which companies are likely to be impacted.
When to Use Sector Strategies
Sector strategies are dynamic approaches which require ongoing portfolio adjustments as economic conditions change and may be successfully implemented at any time during the economic cycle. The goal is to anticipate where the economy is headed and which sectors are most likely to benefit or struggle given expected business conditions. Sectors that are expected to outperform are overweighted while those expected to underperform are underweighted or avoided.
The Economic Cycle
Generally speaking, economic expansion is accompanied by low to rising interest rates, growing consumer optimism and strong employment numbers. During contraction, interest rates have peaked or are falling, consumers have slowed spending, and unemployment is on the rise.
Looking more closely, consumer demand for goods and services typically increases during economic expansion due to supportive monetary policy, positive sentiment and strong employment numbers.
Rather than buy just the basic necessities, consumers spend their extra income on more discretionary items. This discretionary spending drives revenue and generally increases stock prices for companies that sell discretionary goods and services. In comparison, companies selling basic consumer goods tend not to perform as well. In an economic slowdown, or contraction, the reverse occurs as consumers cut back on their discretionary purchases, yet continue to buy the necessities. In this type of environment, consumer staple companies tend to outperform their consumer discretionary counterparts.
Example: Sector Performance
Recent history shows sector performance has often, and substantially, diverged during changing economic environments. Obviously, these sector return differences present both risks and opportunities for investors.