Market structure
Sector Rotation: The 11 Sectors and How Money Moves Between Them
The eleven equity sectors, what each is sensitive to, the classic rotation through the business cycle, and how relative strength shows where money is moving.
Updated · 3 min read
The eleven sectors
The Global Industry Classification Standard divides the equity market into eleven sectors, and every stock in the S&P 500 belongs to exactly one. The sector exchange-traded funds that track them are among the most traded instruments in the world, which makes the sectors tradeable as well as descriptive.
| Sector | What it holds | Most sensitive to |
|---|---|---|
| Information technology | Software, semiconductors, hardware | Real yields, capital spending cycles |
| Health care | Pharma, devices, insurers, services | Little; defensive |
| Financials | Banks, insurers, asset managers, exchanges | The yield curve, credit conditions |
| Consumer discretionary | Retail, autos, travel, restaurants | Employment, consumer confidence, rates |
| Communication services | Media, telecoms, interactive platforms | Advertising cycles; part growth, part defensive |
| Industrials | Machinery, aerospace, transport, construction | Manufacturing orders, the business cycle |
| Consumer staples | Food, household goods, tobacco, retail staples | Little; defensive |
| Energy | Oil and gas producers, services, pipelines | The oil price, the dollar |
| Utilities | Electric, gas and water utilities | Bond yields; a bond proxy |
| Real estate | Listed property trusts | Bond yields; a bond proxy |
| Materials | Chemicals, metals, mining, packaging | Commodity prices, China, the dollar |
Six are cyclical, meaning their earnings rise and fall with the economy: discretionary, industrials, materials, financials, energy and, by valuation if not by earnings, technology. Four are defensive, their earnings steady through a downturn: staples, utilities, health care and, mostly, real estate. Communication services is both, holding platforms that trade like technology and telecoms that trade like utilities.
The classic rotation
Sector rotation is the observation that leadership passes from one group to another as the business cycle turns, in a sequence that has repeated often enough to be a map:
- Early cycle, as a recession ends and rates are low: financials, consumer discretionary, industrials and real estate lead, the groups that benefit first from cheap money and recovering demand.
- Mid cycle, as growth is established: technology and industrials lead, as companies spend on capacity.
- Late cycle, as inflation rises and the central bank tightens: energy and materials lead, with the commodities they sell, and staples begin to outperform as investors look for earnings that will hold.
- Recession: utilities, health care and staples lead by falling least, and the bond proxies rally as yields fall.
The map is a tendency, not a timetable. Cycles differ in length, technology has led through more of the last decade than the map predicts, and the rotation into defensives sometimes comes months before the economy turns and sometimes not at all.
Reading rotation on the tape
The working tool is relative strength: a sector's price divided by the index's, charted over time. A rising ratio means the sector is outperforming whatever the index is doing. Ranking the eleven sectors by their returns over one week, one month and three months shows which groups are gaining leadership and which are losing it, and a sector that leads the one-week ranking while sitting at the bottom of the three-month one is where a rotation may be starting.
Several pairings act as gauges. Discretionary against staples measures risk appetite in the consumer: when discretionary leads, investors expect spending to grow. Cyclicals against defensives as a whole does the same for the market. Utilities and real estate against the index track bond yields: when yields fall, the bond proxies rally. Banks against the index track the yield curve: a steeper curve helps them. Energy follows the oil price with little else in the way.
Rates and sectors
The sector most people now watch for rate sensitivity is technology, and specifically the long-duration growth names whose earnings lie years out: when real yields rise, those earnings are discounted more heavily, and the sector falls more than the index. Utilities and real estate are hurt in the same way for a different reason, because their dividends compete directly with bond coupons. Financials are the mirror image, helped by higher rates and a steeper curve as long as credit holds up.
On the desk
The insights page ranks the sectors by return over several windows and reads the rotation and the risk-on or risk-off balance from them. The sectors notebook applies the desk's weighted-evidence method to the group as a whole, and the heatmap groups every S&P 500 member by sector so the day's rotation is visible as colour.
Questions
- What are the 11 stock market sectors?
- Information technology, health care, financials, consumer discretionary, communication services, industrials, consumer staples, energy, utilities, real estate and materials, as defined by the Global Industry Classification Standard. Every S&P 500 stock belongs to one of them.
- What is the difference between cyclical and defensive sectors?
- Cyclical sectors, such as consumer discretionary, industrials, materials, financials and energy, have earnings that rise and fall with the economy. Defensive sectors, such as consumer staples, utilities and health care, have earnings that hold up in a downturn and tend to fall less when the market falls.
- Which sectors do well when interest rates rise?
- Financials, and banks in particular, benefit from higher rates and a steeper yield curve. Technology growth stocks, utilities and real estate tend to underperform, the first because distant earnings are discounted more heavily and the other two because their dividends compete with bond yields.
- How is sector rotation measured?
- By relative strength: a sector's price divided by the index's, charted over time, and by ranking the sectors' returns over one week, one month and three months. A sector climbing the short-term ranking from the bottom of the long-term one is where a rotation may be beginning.
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