Sectors and Industries

Cyclical and defensive, and what the labels are worth

Sectors are loosely sorted into cyclicals, whose demand tracks the economic cycle, and defensives, whose demand is comparatively steady.

• Cyclical: consumer discretionary, industrials, materials, energy, financials and much of technology. Revenue swings with growth, credit conditions and capital spending.
• Defensive: consumer staples, utilities, healthcare. People buy food, electricity and medicine in a recession, so revenue falls less.

The labels describe tendencies measured over past cycles, and they fail regularly. Utilities are defensive on demand and highly rate-sensitive on valuation, because they carry heavy debt and are held for yield, so they can fall hard in a rate shock while their revenue is untouched. Healthcare is defensive on demand and exposed to policy risk, which arrives on a political timetable rather than an economic one. Treat the labels as a starting hypothesis to check, not a property you can rely on.

Sector rotation is the other reason to track this. Money moves between sectors as conditions change, and the leadership of one cycle is frequently not the leadership of the next. That has a practical consequence for anyone who builds a portfolio by buying what has done well recently: the resulting holdings are concentrated in whatever led the last cycle, which is the group with the least room left and the most crowded positioning.

Where the classification stops being useful

Large companies outgrow their labels. A firm classified as consumer discretionary may earn most of its profit from a cloud computing division. A company classified as communication services may be, functionally, an advertising business. Classification is assigned at company level from the dominant revenue line, so any conglomerate is filed under something that describes part of it.

Supply chains also cut across sectors. An airline is classified as industrials and is in practice a leveraged bet on the oil price, which is energy. A homebuilder is consumer discretionary and is in practice a bet on mortgage rates, which is financials. The sector tag tells you what the company sells. It does not tell you what moves the share price, and those are different questions.

Running a sector audit in ten minutes

The exercise is simple and most people have never done it. List every holding with its weight. Add the sector for each. Sum the weights by sector and look at the largest number.

Then do the harder version. Next to each holding write the single condition that would hurt it most: a rate rise, an oil spike, a consumer slowdown, a regulatory decision. Sum the weights by condition instead of by sector. That second table is the real exposure map, and it is usually more concentrated than the first. The gap between the two tables is what surprises people in a drawdown, and it is the reason portfolio-level risk limits have to be set on the exposure rather than on the position count. The drawdown calculator shows what that concentration costs when the shared condition arrives.