Tahoe-Truckee Market Beat: Phases of the business cycle

The S&P 500 index is broken down into eleven different sectors. Each sector contains several sub-industries. When investing, it’s a good idea to diversify and make sure you have exposure to various sectors and industries. The index is capitalization weighted, which means that the larger companies have more weighting in the S&P 500.

The index is not broken down evenly into the eleven sectors. Currently the S&P is over 20% in the Information Technology sector, over 14% Health Care and over 12% Financials. The smallest sector is Telecommunication services at 2.6%. So, if you own an S&P index fund you don’t have even exposure to all eleven sectors.

The sectors and sub-industries can be broken down into four industry types. The four types are defensive, cyclical, growth and special situations. These industry types perform differently during the distinct phases of the business cycle.

The defensive industries are the least affected by the business cycle. Defensive industries include Consumer Staples, Energy and Utilities. Stocks in these sectors tend to have fairly stable earnings because people will still consume food, pharmaceuticals, and energy when the economy is slow.

The cyclical industries are much more sensitive to the business cycle and interest rates. The Consumer Discretionary sector is cyclical. Consumers tend to purchase big ticket items like automobiles and appliances when the economy is doing well and when interest rates are relatively low, because many consumers finance these types of products.

Some industries are also counter cyclical; gold mining for example has historically performed better when the business cycle is down as money can tend to flow into precious metals when the economy is slow.

The growth industries include companies in the Information Technology sector, like computer stocks and bio-tech stocks that are in the Health Care sector. These types of companies can grow their earnings rapidly and outperform the market when they are in the growth phase of their business life. Companies go through four phases during their life span; introduction, growth, maturity and finally decline.

The fourth category is referred to as special situation stocks. Companies that fall into this category could have some unusual profit potential due to a unique circumstance, like new management or a new product.

It’s important to understand the four major industry types, when diversifying a portfolio, so you can be prepared for what can occur during the different phases of the business cycle.

Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results