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Stock Selection Strategies: Stock Market Sectors and Sector Rotation

If you’re interested in a sector perspective, you may appreciate the information available on the Sectors & Industries page. You’ll find the performance and fundamental data for different sectors and industries in both Canada and the United States. Industries are a sub-category of sectors which you can explore in depth to find specific companies operating in each industry. For example, you can research the dividend yield, price to earnings ratio (P/E) or one-year return of Canadian natural gas utilities as a whole or research individual companies.

Sector rotation is an investment strategy that consists of moving money from one sector to another in an attempt to beat the market. Over time, an economy goes through periods of growth (i.e. expansion) and periods of contraction (i.e., recession). Economic growth typically benefits certain sectors, known as cyclical sectors, while less economically sensitive (or non-cyclical) sectors perform better during harder times. Non-cyclical sectors are also known as defensive sectors, because their stable dividends and earnings are regarded as a defense against stock market declines (although no stock is immune to an economic downturn). As the economy changes, therefore, an investor may choose to shift investment assets from one sector to another.

Business Cycles and Cyclical Sectors

A period with one recession and one expansion is known as a business cycle. This cycle can be broken down into four parts, each of which is associated with the outperformance of certain sectors.

Early recession: The economy begins to slow, as measured by gross domestic product (GDP) , and consumer expectations are at their worst. Industrial production is falling sharply, interest rates are at their highest and the yield curve is flat or even inverted (meaning that long-term interest rates are equal to or lower than short-term rates). Historically, the following sectors have profited during these times:

  • Consumer staples, such as food producers and grocery retailers (near the beginning)
  • Health care
  • Utilities (midway)

Recession: Economic growth is down (i.e., GDP is contracting), and industrial production is at its lowest point. The unemployment rate is high. Interest rates begin to fall, and the yield curve is normal (meaning that long-term rates are higher than short-term rates). Although consumer expectations are low, they are beginning to improve. The sectors that have historically performed well in this stage include:

  • Consumer discretionary, such as car manufacturers and clothing retailers (near the beginning)
  • Financials
  • Information technology (near the end)

Early recovery: The economy begins to improve, and consumer expectations continue to rise. Industrial production begins to grow. Interest rates reach their lowest point, and the yield curve is either normal or has begun to steepen (meaning long-term interest rates are increasing relative to shorter-term rates). The sectors to consider investing in at this stage include:

  • Financials (near the beginning)
  • Transportation (near the beginning)
  • Other industrials
  • Energy (near the end)

Late/full recovery: At this point in the business cycle, interest rates are usually rising rapidly and the yield curve has flattened. Industrial production is slowing and consumer expectations are beginning to fall. Historically, the most profitable sectors in this stage have included:

  • Energy (near the beginning)
  • Materials, including precious metals

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