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Sectors, Defensive Stocks, and Cyclical Stocks

Stocks are often classified into sectors, defined by the type of business they are in. There are eleven sectors generally recognized by investors. Frequently stocks within a sector will move up or down as a group, depending on the economic conditions. Investors will try to ride the stocks within a sector while it is in favor and switch to stocks of a different sector when the conditions change. This is referred to as sector rotation.

Nine sectors are cyclical in nature and two sectors are defensive in nature.

Cyclical stocks are sensitive to economic fluctuations and tend to exhibit more radical swings, correlated with the overall business cycle. They have very strong performance in an expanding economy and very weak performance in a weak economy. The stock prices of cyclical companies tend to lead an upturn or a downturn in the economy. Investors will try to buy these stocks just before the upturn and sell them just before the downturn.

Cyclical sectors generally include:

  • Basic Materials
  • Capital Goods
  • Communications
  • Consumer Cyclical
  • Energy
  • Financial
  • Technology
  • Transportation

On the other hand, defensive stocks tend to have stable performance in economic downturns and upturns. They provide balance in a portfolio and protection in a falling market, but they don't climb as fast as cyclical stocks in a rising market. Defensive sectors include utilities and consumer staples (food and tobacco). The stock prices of defensive companies will not decline as much in a downturn and thus will not increase as much in an upturn either. The consumer does not have as much discretion to eliminate purchases in this area. Whether the economy is good or bad, they still need to eat and they need utilities.

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