Intro

A sector refers to a part of the economy where businesses engage in similar or related activities, products, or services. It encompasses broad categories of companies with shared business interests, such as natural resource extraction and agriculture.

In this article we’re providing an overview to different methods to describe sectors of the economy used by academia and analysts.

primary, secondary, tertiary, and quaternary

The classification of economic activities into different sectors, such as the primary, secondary, tertiary, and quaternary sectors, is generally attributed to the work of economists such as Allan Fisher, Colin Clark, and Jean Fourastié over the course of the 20th century.

Allan Fisher introduced the distinction between primary (agricultural and mining), secondary (manufacturing), and tertiary (services) sectors in the 1930s. But the idea of the quaternary sector, which focuses on knowledge and information services, evolved later as economies became more complex and technology-driven.

  • Primary Sector: This is the base of any economy and includes all activities where natural resources are extracted from the earth. This includes agriculture, mining, forestry, and fishing. The primary sector is fundamental as it provides raw materials for other industries and goods for the basic needs of the population.
  • Secondary Sector: Often referred to as the manufacturing sector, this involves transforming raw materials from the primary sector into finished goods and products. This sector includes all forms of manufacturing, processing, and construction. Industries in the secondary sector produce a wide range of products, from buildings and infrastructure to electronics and consumer goods.
  • Tertiary Sector: Also known as the service sector. The tertiary sector includes a wide variety of industries such as retail, entertainment, financial services, health care, and education. Services can range from cutting hair and cooking food to teaching students and treating patients, playing a crucial role in the economy by supporting the primary and secondary sectors and meeting the daily needs of consumers and businesses.
  • Quaternary Sector: Sometime seem as Tertiary knowledge-based sub-sector. It includes services such as information technology, financial planning, consulting services, education and other knowledge-driven economic activities. This sector focuses on the manipulation of information and is essential for the innovation that drives economic growth.

Sector vs. Industry

A sector encompasses a broad segment of the economy, comprising numerous companies with similar business activities. Conversely, an industry is a more specific classification within a sector, representing a narrower grouping of companies that focus on particular aspects of the sector’s broader category. Therefore, industries are more precise subdivisions of a sector, delineating companies by their more specialized operations within the larger economic grouping

Sectors may have companies that don’t necessarily compete with each other, while industries tend to represent corporations that are in direct competition.

Investment Sectors

In the financial markets, the economic sectors are broken down into sub-sectors to help investors compare companies with similar business activities. While economic sectors represent a broad representation of the economy, investment sectors further define and categorize companies.

Investment sectors are important because they help measure how well an economy is performing based on the financial performance of the corporations within that sector.

Several schemas are used to classify investment sectors, providing a systematic way to organize industries and companies for investors. Here are some of the most prominent sector classification schemas:

  • Standard Industrial Classification (SIC): Although largely replaced by NAICS in the United States, the SIC system is still used by some investors and market researchers. Developed in the 1930s, it categorizes industries primarily based on a company’s primary business activity. The system uses a four-digit code to classify industries into a sectorial structure.
  • Global Industry Classification Standard (GICS): Developed in 1999 by MSCI and Standard & Poor’s, GICS is a widely used classification system that categorizes companies into sectors and industries based on their principal business activities. GICS consists of 11 sectors, which are further divided into 24 industry groups, 69 industries, and 158 sub-industries.
  • Industry Classification Benchmark (ICB): Created by FTSE Russell, the ICB is another prominent classification system used globally. It divides the economy into 10 industries, which are further subdivided into 20 supersectors, 45 sectors, and 173 subsectors. This system is used for structuring investment funds, benchmarking performance, and other financial products.
  • North American Industry Classification System (NAICS): Developed jointly by the U.S., Canada, and Mexico, NAICS is used by government agencies to classify business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the business economy. NAICS is more detailed than the previously mentioned systems, which are more focused on financial markets.
  • Refinitiv Business Classification (TRBC): Developed by Thomson Reuters and now part of London Stock Exchange Group following the acquisition of Refinitiv.

The Global Industry Classification Standard (GICS)

is a widely recognized classification system for equities, developed jointly by Morgan Stanley Capital International (MSCI) and Standard & Poor’s (S&P) in 1999. GICS is designed to provide a consistent, detailed, and standardized framework for classifying companies based on their principal business activities.

GICS is widely used by the global financial community. It provides clear classifications of companies into sectors and industries, thus aligning investment portfolios with strategic objectives. It enables performance benchmarking, allowing investors to assess company, sector, or industry performance against benchmarks and peer groups. Furthermore, GICS classifications are fundamental in developing financial products such as ETFs, mutual funds, and derivatives, facilitating targeted investments in specific sectors or industries. Both major U.S. exchanges NYSE and NASDAQ use the GICS system. The exchange’s website often lists GICS classifications in the company profile.

GICS organizes companies into a hierarchical structure with four levels of classification:

  • Sectors: The highest level, representing the broadest categorization of companies. There are 11 sectors in the current GICS framework, each representing a distinct segment of the economy.
    • Energy
    • Materials
    • Industrials
    • Consumer Discretionary
    • Consumer Staples
    • Health Care
    • Financials
    • Information Technology
    • Communication Services
    • Utilities
    • Real Estate
  • Industry Groups: Each sector is divided into industry groups, which provide a further breakdown based on more specific business activities than the broader sector classification. For instance, the Financials sector includes industry groups like Banks, Diversified Financials, and Insurance.
  • Industries: Each industry group contains industries, which offer a more focused view of the economic activities than industry groups.
  • Sub-Industries: The most detailed classification, sub-industries provide the most specific categorization of business activities. For example, within the Software & Services industry, there are sub-industries like Application Software, Data Processing & Outsourced Services, and Internet Services & Infrastructure.

We will cover Sectors down to Sub-Industries in the next articles.

Sector Analysis

Sector analysis operates on the premise that specific sectors of the economy perform differently at various phases of the business cycle (Read also Phase of a Bubble). The business cycle itself is characterized by fluctuating levels of economic activity within an economy over time, marked by periods of expansion, where there is growth, and periods of contraction, where the economy experiences a decline.

Early in the business cycle during the expansion phase, for example, interest rates are low and growth is beginning to pick up. During this stage, investors or analysts who do a sector analysis would focus their research on companies that benefit from low interest rates and increased borrowing. These companies often perform well during periods of economic growth. These include companies in the financial and consumer discretionary sectors.

Late in an economic cycle, the economy contracts and growth slows. Investors and analysts will turn their attention to researching defensive sectors, such as utilities and telecommunication services. These sectors often outperform during economic downturns.

This movement of money invested in stocks from one industry to another as investors and traders anticipate the next stage of the economic cycle is called Sector rotation in this context.

To provide more practical example we can look at historical data to study dependencies between four fundamental stages of the economic cycle of the economic cycle and sector performance. It’s important to note that real economy sector stage often lag behind the overall market cycle by several months.

Full Recession

This period presents challenges for both businesses and job seekers. The Gross Domestic Product (GDP) is shrinking on a quarter-over-quarter basis. Interest rates are on the decline, and consumer expectations are at their lowest. The yield curve remains normal. Historically, certain sectors have tended to fare better during this stage, including:

  • Cyclicals and transports, typically at the start
  • Technology
  • Industrials, usually towards the end

Early Recovery

Things are beginning to improve. Consumer expectations are on the rise, and industrial production is increasing. Interest rates have reached their lowest point, and the yield curve is starting to steepen. Historically, the sectors that have performed well at this stage include:

  • Industrials, typically at the start
  • Basic materials
  • Energy, generally towards the end

Late Recovery

Interest rates are climbing quickly, and the yield curve is flattening. Consumer expectations are starting to fall, and industrial production has leveled off.

Traditionally, the sectors that have seen profitability during this stage include:

  • Energy, usually at the beginning
  • Consumer staples
  • Services, typically towards the end

Early Recession

The economic outlook is bleak. Consumer expectations have plummeted to their lowest, industrial production is on the decline, interest rates have peaked, and the yield curve is flat or potentially inverted. Historically, certain sectors have managed to perform well during such challenging times:

  • Services, typically at the start
  • Utilities
  • Cyclicals and transports, generally towards the end

In the next articles we’ll cover all sector details.