If you follow my investments you can see that I mainly invest in specific sectors to diversify my investments. But I am not the only one. One of the keys to successful investing is understanding the various sectors of the economy and how they can affect the performance of stocks. In this article, we’ll look at sector investing and how it can help investors make more informed decisions.
What is Sector Investing?
Sector investing consists of buying shares in companies operating in specific sectors of the economy, such as the technology, finance or utilities sector. The idea behind this investment strategy is that companies within the same sector are influenced by the same market forces. Therefore their performance is related to the overall health of the sector.
For example, if the technology sector is growing, then technology companies will typically experience increased demand for their products and services and see an increase in their stock price. Similarly, if the utilities sector is having a tough time, utility companies could experience a decrease in demand and their stock prices.
The sector investing strategy is particularly popular with investors looking to diversify their investment portfolio. Investing in different sectors can help investors balance risk in their portfolio, as the performance of one sector can offset any losses in another sector.
Additionally, investing in sectors can be a winning strategy for investors who follow a value investing philosophy. These investors seek out companies that are undervalued relative to their true value. Often they find investment opportunities in sectors that have been underpriced by other investors.
For example, assume the utilities sector is having a difficult time due to falling interest rates. Value investors may find utility companies that have been overly penalized by the market and therefore offer an attractive investment opportunity.
How to choose the sectors in which to invest?
Choosing which sectors to invest in can be a challenge, but there are a few things investors can do to streamline the decision-making process.
First, investors should seek to understand macroeconomic trends. For example, if the economy is expected to grow, consumer-related sectors could benefit from higher revenues. Similarly, if oil prices are expected to rise, the energy sector could have growth potential.
Additionally, investors should seek to understand which sectors are leading in terms of performance and valuation. For example, the technology sector has been a leader in recent years and many stocks in this sector have been well rated. However, this could mean that valuations have become too high and shares could be subject to a correction.
Correlation between sectors and economic cycles
Another aspect to consider when choosing which sectors to invest in is the correlation between these sectors and economic cycles. Economic cycles represent the periodic alternation between phases of economic growth and phases of recession. Each sector of the economy can be affected differently by these fluctuations.
In general, cyclical sectors, such as the technology, tend to have more exposure to economic cycles than non-cyclical , such as health care or utilities.
Cyclical sectors can benefit from an economic expansion. As demand for non-fundamental goods and capital increases. While in an economic downturn, consumers tend to cut back on spending and investment, affecting these sectors significantly.
On the other hand, non-cyclical sectors are less affected by economic fluctuations, as their products and services are considered essential. People demand them regardless of the economic environment.
These information can be used in two ways:
- To balance risk in the portfolio, choosing sectors that are negatively or lowly correlated between them to build a diversified and balanced portfolio.
- To make a tactical asset allocation in a way to gain/protect temporarily in a particular phase of the market.
How do I use sector investing?
I strongly believe that correlations between sectors exist and that the economy is bound to repeat itself. I am also convinced that some sectors are “stronger” than others. This is due to several factors in my opinion.
Healthcare sees our survival instincts at play. utilities our desire to stay in our comfort zones. Technology is our intellect and desire to innovate. I think these 3 sectors demonstrate our human soul in a comprehensive way.
This is why I continue to accumulate positions in these 3 sectors through accumulation ETFs.
Also unlike simply buying a global index with the various sectors within it, I can average their carrying price over the months/years that those sectors are despised by other investors.