The role of stock sectors in investments
Joel Dresang: Kyle, we know from research that mostly what drives investment returns over the long run is allocation, so the balance between stocks and bonds. What I want to do with you is to zoom in on the stock side of that balance and to look at stock sectors. First, explain what those sectors are.
Kyle Tetting: So Joel, what we’re really looking at when we’re looking at sectors is the ability to break down where an individual stock falls – and especially relative to its economic sensitivity.
So we can really get an idea of whether a stock is defensive relative to the economy, whether it’s a little bit more sensitive to the economy more broadly or whether it’s very cyclical. Much like the economy has ebbs and flows, and there are a lot of stocks that fall into that category as well.
Joel: So let’s talk about those stock sectors. First start with the defensive stocks.
Kyle: So those defensive stocks when you think about the kinds of things that you’re still going to go buy as a consumer, the kinds of products you’re still going to use even if the economy isn’t doing as well as it could. And that’s healthcare stocks and utility stocks, which really fill that kind of defensive bucket.
Joel: And then there’s a sector that’s more sensitive to the economic cycles?
Kyle: Yes, so that sensitive sector that falls kind of in the middle, is things like telecom stocks, things like energy, industrial stocks and technology stocks, those things which do have some of those defensive characteristics but are still going to participate when the economy is really taking off, but they still are products that we use every day.
Joel: And then the cyclical stock sector?
Kyle: As you think about those cyclical stocks – the ones that really participate when the economy’s taking off but at the same time really fall apart as the economy is falling apart. It’s things like those consumer cyclical stocks or the discretionary consumer stocks: financial services, basic materials and real estate, which really are very susceptible to the economic cycle.
Joel: So why do those stock sector weightings matter?
Kyle: As investors what we’re really trying to do is make sure that we have an appropriate allocation to everything. But at the same time, there’s a lot of stuff going on in the world at any given time. So, what we’re trying to do is take advantage of opportunities in the particular corners of the market as they present.
A great example is to find a sector where maybe valuations are a little bit high or earnings might be expected to increase pretty substantially. We might underweight the first and overweight the second simply because the fundamentals are favorable.
Joel: What do you as an advisor do, knowing those weightings?
Kyle: As we look at investor portfolios, what we’re really focused on is that most importantly, they have an overall balance. Second of all, that as we look at the investor’s individual concerns, as we talk to them about the opportunities we see in the world and the opportunities that they see in the world, that their portfolio truly reflects that.
And so as we’re looking at their portfolio, what we’re really trying to do is make sure that we’ve taken advantage of those opportunities with an appropriate balance.
Joel: What should investors do about their stock sector weightings?
Kyle: You know, Joel, I think this really informs the conversation as we look ahead to what we expect for the economy. And again, I can’t stress enough the importance of balance.
But if we expect that things could heat up from here, or that things could slow down from here, it’s going to allow investors to really take advantage of the opportunities they see in the market and prepare their portfolio for the risks that they expect to come.
Joel: And it’s not getting all in or all out of any one sector.
Kyle: Yes, Joel. Timing the market is very difficult and represents just a very small piece of performance in a portfolio in the first place. So, it makes much more sense to have that allocation to everything.
But instead of trying to jump in and out of the various sectors, weight those sectors, which represent opportunity appropriately, weight those sectors which represent risk appropriately, and know that as an investor, you’re going to take advantage of the opportunities everywhere. But by leaning into the areas that represent the best opportunity, you can do just a little bit better than you otherwise would have.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
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(initially posted December 1, 2017)