Bellwether Stock

What Is a Bellwether Stock?

The term bellwether stock refers to a stock that is believed to be a leading indicator of the direction of the economy, a specific sector, or the market as a whole. Because they're considered market leaders, strong earnings reported by bellwether stocks indicate a strong economy.

Their market performance may also signal how a sector or the market will perform. Conversely, if the stock does poorly, it often indicates the same for the economy. As such, they are generally considered economic indicators. Bellwether stocks are typically large-cap blue chip stocks.

Understanding Bellwether Stocks

Bellwether stocks are normally used to gauge the general performance of the market and the overall economy. That's because these are stocks of companies that are profitable and stable. As such, they have proven themselves to be a dominant force in a specific industry. So when a bellwether has a positive quarter, it signals a positive turn for the market or economy, while negative earnings may indicate a slowdown.

As mentioned above, bellwether companies are traditionally large-cap equities, with some falling into the blue chip category. They normally have established customer bases and formidable brand loyalty. Some have also proven to be resistant to economic downturns.

Bellwethers form the foundation of most major market indices, where large-cap bellwethers dominate the Dow Jones Industrial Average (DJIA), the S&P 500, and the Nasdaq. They also move alongside these indices, so if an index goes up, so does the price of a bellwether stock.

One thing to note is that bellwethers come and go. That means their status may change over time for any number of reasons, including missing analyst expectations or continued poor performance in relation to the index. Others can simply fall off their pedestal over time. For instance, General Electric (GE) was once a bellwether stock, but some analysts say that it no longer is because of changes to its corporate structure, that being that the company's focus is more streamlined.

Special Considerations

Many investors turn to bellwether stocks hoping to turn a profit. That's because these stocks are often considered market or economic indicators. But that doesn't make them the best investment choice. Here's why. Companies that become bellwethers often see the days of market-beating growth behind them. And once they reach a certain size, any plans for meaningful expansion become difficult.

Rather than investing in them, investors may want to consider keeping tabs on their performance, using them as indicators of the market or economy. They are generally better off putting their money into startups and other companies that have a lot of growth potential. Companies like these are often poised to become bellwethers in the future.

Examples of Bellwether Stocks

Many different stocks may be classified as bellwethers. For instance, Alcoa (AA) is often considered a bellwether for the economy because it operates in a cyclical industry, and if it reports strong earnings, that suggests the economy is strong. Its report is also considered a bellwether for the corporate earnings season because it's the first major company to report earnings.

Here are a few others:

• FedEx's (FDX) strong revenues and earnings suggest strong consumer and business shipping activity, which ebbs and flows with the strength of the economy.
• Caterpillar (CAT) is often considered a bellwether for both the domestic and global economies as a whole. Global sales of its construction equipment can signal global economic health.
• Some analysts consider Alphabet (GOOGL), the parent company of Google, to be a bellwether of the technology sector.