What Does Sector Analysis Mean?

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. 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.

Sector Analysis Explained

Sector analysis is based on the premise that certain sectors perform better during different stages of the business cycle. Early in the business cycle, for example, interest rates are low and growth is beginning to pick up. During this stage, companies that benefit from low-interest rates and increased borrowing often do well. These include companies in the Financial and Consumer Discretionary sectors. Late in an economic cycle, when growth is slowing, defensive sectors such as Utilities and Telecommunication Services often outperform.

In sector rotation strategies, investors may define sectors in a variety of ways. But a commonly used taxonomy is the Global Industry Classification Standard (GICS) developed by MSCI and Standard & Poor's. GICS consists of 11 sectors, which are broken down into 24 industry groups, 68 industries, and 157 sub-industries. The Consumer Staples sector, for example, consists of three industry groups: 1) Food & Staples Retailing, 2) Food, Beverage & Tobacco, and 3) Household & Personal Products.

These industry groups are broken down further into industries. Food, Beverage & Tobacco, for example, consists of those three, which are then broken into sub-industries. The Beverage industry, for example, is made up of three sub-industries: Brewers, Distillers & Vintners, and Soft Drinks.

Sector rotators and others who employ a top-down approach don't necessarily limit themselves to sectors. They may choose to emphasize industry groups, industries, or sub-industries.