Lessons › Fundamentals and news › Sectors and the business cycle

World 7 · Fundamentals and news · lesson 12 · level 4

Sectors and the business cycle

Not all companies do well at the same time; some shine in a boom and others hold up better in a slowdown.

In one line

Not all companies do well at the same time; some shine in a boom and others hold up better in a slowdown.

Explained simply

Think of the seasons: ice-cream shops do best in summer and umbrella shops in the rainy season. The economy has seasons too, called the business cycle, and different kinds of companies tend to do better in different seasons. These are loose habits, not fixed rules.

The lesson

Stocks are grouped into sectors, such as banks, technology, energy and consumer staples. Cyclical sectors tend to be more sensitive to economic growth, while defensive sectors, such as utilities and everyday goods, usually swing less. Comparing a stock with its index, called relative strength, shows whether it is leading or lagging. All of these tendencies are loose and often break, so they add context rather than signals.

A worked example

Illustrative example: a stock is at 200 while its index is at 10,000, so its relative strength is 0.02 (200 divided by 10,000). A month later the stock is at 220 and the index at 10,200, giving about 0.0216 (220 divided by 10,200). The line rose because the stock gained 10% (20 divided by 200 times 100) while the index gained only 2% (200 divided by 10,000 times 100), so the stock led.

The same idea at four levels

1. Beginner. Stocks are grouped into sectors, such as banks, technology, energy and everyday goods.
2. Foundation. Cyclical sectors tend to rise and fall more with the economy, while defensive sectors usually swing less.
3. Intermediate. Relative strength = stock price ÷ index level, and a rising line means the stock is leading its index.
4. Advanced. A textbook business-cycle wheel suggests which sectors have often led at each stage, but real cycles rarely follow it neatly.
5. Expert. Experts use sectors and relative strength as context for where to look, never as a timetable, and they know relative strength is different from RSI.

Mistakes to avoid

• Treating the sector wheel as a timetable.
• Confusing relative strength, which compares two charts, with RSI, which is a momentum indicator.
• Assuming a defensive sector cannot fall in a slowdown.

Goal of this lesson: Understand how different sectors tend to behave at different stages of the economy.