Stocks · Intermediate · 5 min

Sectors and industry cycles

You can sort companies into sectors using the GICS system, tell cyclical from defensive businesses, and explain why sectors react differently to the economy.

Not all stocks fall alike

When news says the economy is slowing, the stock market rarely falls evenly. Some shares drop sharply, while others barely move or even rise. To a beginner, this can look random.

Much of it is explained by one simple question: what does the company sell, and do people still buy it when money is tight? That question is the basis of sectors, the way the market groups companies by business.

Eleven sectors

A sector is a group of companies with similar businesses. The most widely used system is GICS, the Global Industry Classification Standard, run by S&P Dow Jones Indices and MSCI. Since its revision in March 2023, it has 11 sectors, 25 industry groups, 74 industries and 163 sub-industries.

The 11 sectors: energy, materials, industrials, consumer discretionary, consumer staples, health care, financials, information technology, communication services, utilities and real estate.

Sectors react differently to the business cycle, the recurring pattern of economic expansion and slowdown:

A cyclical stock belongs to a company whose sales depend strongly on the economy. Cars, travel, construction, luxury goods and raw materials are typical. In good times, profits can rise fast. In a downturn, they can collapse.
A defensive stock belongs to a company that sells what people need in any year: food, household goods, electricity, medicine. Its profits usually change less, and so does its share price, in both directions.

Interest rates matter too. Banks, real estate and utilities often react strongly to changes in rates, for different reasons: banks earn on lending, real estate and utilities often carry a lot of debt.

Stock prices move on expectations, as you saw in the lesson on news. Sectors often start to react months before a turn in the economy shows up in the data. That is why the cycle is easy to describe and hard to time.

Profits decide

Two fictional companies enter a recession.

A carmaker sells 20% fewer cars. Because its factories cost the same to run, its profit halves. Its share falls 40%.
An electricity supplier sells almost the same amount of power. Its profit dips 3%. Its share falls 8%.

The difference is not management or luck. It is the kind of demand each company depends on. When the economy recovers, the order often reverses: the carmaker's profit can double, while the utility's grows slowly. An investor who held only the carmaker had a much wilder ride, in both directions, than one who held both. Mixing sectors does not remove risk, but it means one kind of shock hits only part of the portfolio.

Common mistakes

"Defensive means safe." Defensive shares fall too, usually less.
Trying to time sector rotation. Cycles are clear in hindsight, rarely in real time.
Ignoring a portfolio's sector mix. Five shares from one sector are not five different risks.
Judging a company only by its sector. Business models within one sector can differ a lot.

The takeaway

Companies are grouped into sectors. Cyclical ones swing with the economy, defensive ones less so. Knowing the sector explains many price moves.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the group whose demand usually holds up better in a recession.

Tap the chart.

People keep buying food, electricity and medicine in hard times. A new car or a holiday can wait.
2How many sectors does the GICS classification have?

Since March 2023, GICS has 11 sectors, 25 industry groups, 74 industries and 163 sub-industries.
3Which of these sectors is usually considered defensive?

Demand for electricity and water changes little with the economy. Discretionary goods and raw materials are more cyclical.
4Does knowing the economic cycle tell you when to switch sectors?

Stock prices react to expectations about the economy, often months before the data shows a turn.

of 4 correct.