Investors who want to look at the “big picture” often start by examining the state of economy and the stock market in general, and then look, in order, at market sectors, at industries within a sector, and then at companies within a given industry.

This week, Value Line provides its quarterly update on the 10 stock sectors we follow, which include nearly 100 industries, highlighting the notable changes that have occurred in the past few months. The sector ranks are based on the Timeliness ranks of the individual stocks within the sectors, and are positioned from 1 (Highest) to 10 (Lowest) in order of attractiveness. We also review changes in sector market capitalization in this article and take a closer look at projected earnings growth and appreciation potential, by sector, in the wake of the stock market’s pullback since the spring.

Sector Investing 9-30-11

Sector Rundown

The Basic Materials continues its run at the top of our list for sector Timeliness this week. Part of the group’s luster is that it is home to the Gold Industry. Gold is enjoying its turn in the spotlight after a long period of dormancy since its last peak around 1980. Compelling reasons for gold to shine include the economic woes of the United States and Europe, plus inflation in the developing nations of Brazil, China, and India. Gold prices may remain elevated until the global economy is on surer footing, to the benefit of gold shares. Several gold stocks hit fresh 52-week highs during the market’s swoon in August.

Sector Rankings 9-30-11

Overall, the order of the sectors remains more defensive than usual, with the traditionally less volatile Utilities and Consumer Staples groups higher than they would be based on earnings growth alone. This week’s big movers on the upside include the Energy sector, up three spots to third place, and the Telecommunications sector, up two notches to the seventh slot. A recovery in oil prices is helping to lift sentiment for many energy companies, and good dividend-paying capabilities on the part of Telecom sector shares may have lifted that group’s relative standing. On the down side, the Consumer Staples and Technology sectors have each fallen appreciably.

Market Cap

Our next table provides the changes in market capitalization that the sectors have experienced since the beginning of the year, as well as each sector’s percentage of total market cap. Changes in market capitalization offer a measure of performance which, as we can see, put a few sectors in a favorable light, but show the struggles several groups have been going through. It has generally been a difficult time for equities since late spring, as fears over financial contagion from Europe and the possibility of a double-dip recession have mounted.

YTD Performance 9-30-11

Investor concerns clearly show up in how the sectors have performed this year, with the defensive Consumer Staples and Utilities groups faring the best, by far. The only other sector to turn in a positive showing is Basic Materials, which may be considered more defensive these days, owing to its inclusion of the Gold Industry. Another factor providing a tailwind for the top three sectors is that they are all relatively small in terms of their percentage of total market capitalization. That means more dollars are chasing a fewer number of stocks. There are just 95 companies in the Consumer Staples group, 91 in Utilities, and 85 in Basic Materials, out of the 1,700 companies that Value Line follows.

At the bottom of the list, the Consumer Cyclical sector is being weighed down by poor recent performance from segments such as the Homebuilding and Newspaper industries. The Industrial sector has also fared poorly as business conditions have eased, with the Metal Fabricating and Power industries lagging of late.
Bringing up the rear is the Financial sector, as it has with regularity in recent years. Bank stocks continue to be in the doghouse on worries about lending conditions, fears that Europe’s woes will head this way, and as regulation has increased. Meantime, low interest rates are hurting insurance companies’ investment portfolios when proceeds from bonds that are maturing need to be reinvested. Deal-making for the buyout shops in the
Public/Private Equity industry had slowed as the economy has flattened out, too.

Growth Potential

Our final table this week summarizes appreciation potential and projected earnings growth by sector and, in doing so, provides a link between the two measures. That is to say, sectors with higher capital gains potential are generally accompanied by greater possibilities for profit growth. 

Innovation is the key theme behind prospects for the Tech and Telecom sectors. Tablets and smartphones are the latest gadgets helping to drive sales and earnings in those sectors, marking an advance in the technology cycle from the laptops and cellphones of just a few years ago. Investors seem to be assuming, with good reason in light of past experience, that another generation of popular consumer-oriented devices will drive earnings and stock prices for these sectors down the road.

3 to 5 Year Appr. 9-30-11

Moving down the list, the Consumer Cyclical sector’s hopes rest on a rise in spending for goods and services that will require better job and income growth for workers than has been the case lately. Our assumption is that more positive employment trends will develop by mid-decade. That would lessen the need for consumers to reduce personal debt, as they have been forced to do in recent years. Meanwhile, the Industrial and Basic Materials sectors are set to thrive once the global economy shifts into high gear. Sectors in the bottom half of the list generally have slower growth and/or higher regulation in common, and aren’t expected to perform as well out to 2014-2016, although over the course of time, just about every sector has its day in the sun.

Notably, the median for price appreciation potential of all 1,700 stocks under our review of 85% is much greater than the 50% figure that prevailed six months earlier. The rise reflects the market correction that has taken place since late April/early May, when the Dow Jones Industrial Average topped out at around 12,900.

Sector Groups 9-30-11

At the time of this writing, the author did not have any positions in any of the companies mentioned.