Sector analysis is an assessment of the economic and financial condition and prospects of a given sector of the economy. Sector analysis serves to provide an investor with a judgment about how well companies in the sector are expected to perform. Sector analysis is typically employed by investors who specialize in a particular sector, or who use a top-down or sector rotation approach to investing.
How do investors use sector analysis?
Investors use sector analysis to assess the economic and financial prospects of a sector of the economy. Investors who use sector analysis believe that certain sectors of the economy perform better at different stages of the business cycle and that identifying these sectors can help them find profitable investments.
Types of Sector Analysis:
Two common approaches to sector analysis are the top-down and sector rotation approaches.
In the top-down approach, the most promising sectors are identified first, and then the investor reviews stocks within that sector to determine which ones will ultimately be purchased. A sector rotation strategy may be employed by investing in particular stocks or by employing sector-based exchange-traded funds (ETFs).
The top-down approach is a type of sector analysis that first focuses on macroeconomic factors that influence an economy, such as unemployment and inflation.
Sector Rotation Approach:
Investors and portfolio managers use a sector rotation approach to rotate their investments in and out of various sectors of the economy. They buy and sell depending on market cycles and trends that influence the profitability of some sectors over others.
Investors who use the sector rotation approach actively shift their investments from one sector to another, depending upon market cycles and trends that impact the potential profitability of various sectors.
Why Do Investors Choose Sector Rotation?
As the economy moves forward, different sectors of the economy tend to perform better than others. The performance of these sectors can be a factor of the stage of the business cycle, the calendar or their geographic location.
Investors seeking to beat the market may spend countless hours reading through articles and research reports. Using a top-down approach, they might develop a basic forecast of the economy, followed by an assessment of which industries hold the most promise. Then the real work begins – trying to find the right companies to buy.
Sector rotation is a blend of active management and long-term investing: active in that investors need to do some homework to select the sectors they expect to perform well; long-term in that you can hold some sectors for years.
Markets tend to anticipate the sectors that will perform best, often three to six months before the business cycle starts up. This requires more homework than just buying and holding stocks or mutual funds, but less than is required to trade individual stocks. The key is to always buy into a sector that is about to come into favor while selling the sector that has reached its peak.
Investors might consider three sector rotation strategies for their portfolios. The most well-known strategy follows the normal economic cycle. The second strategy follows the calendar, while the third focuses on geographic issues.
The Stock Market Cycle in Four Stages: The Stock Market Cycle is also known as ‘The Key to Maximum Returns’.
The stock markets don’t move with the economic cycle. They move in anticipation of the economic cycle, or at least they try to. The market cycle can be divided into four stages:-
- Market bottom: A long-term low point is reached.
- Bull market: The market rallies from the market bottom.
- Market top: The bull market starts to flatten out.
- Bear market: Here THE market goes down
Most of the time, financial markets attempt to predict the state of the economy anywhere from three to six months into the future. That means the market cycle is usually well ahead of the economic cycle again. This is the precursor to the next market bottom
This is crucial for investors to remember because the market will always start to look ahead to recovery. While the economy is in the pits of a recession.
Disclaimer: All the information here in this article is for educational purpose only. Investing of any kind involves risk. While it is possible to minimize risk, your investments are solely your responsibility. It is imperative that you conduct your own research. We are sharing our inputs for to educate traders and investors with no guarantee of gains or losses on investments. Please learn and analyze your stocks by yourself or you can contact to your financial advisor.