Investing in sectors: where are the best market opportunities?

By identifying and investing in sectors as their fortunes start to pick up, you can boost your portfolio returns significantly. Every dog has its day, as the old saying goes, and so does every investment sector. 

Today, Big Tech is in vogue and has delivered sparkling returns for investors in recent years. But the investment backdrop is continually evolving and tomorrow it could be another sector entirely. As such, it is worth familiarising yourself with the main tailwinds that support each sector’s growth. Markets don’t always follow the rules, but some familiar patterns start to emerge over time. 

“Many investors take the view that a ‘bad’ stock in a ‘good’ (or fashionable) sector will outperform a ‘good’ stock in a ‘bad’ sector, at least in the near term, and so it may be worth assessing which industries are seen to be thriving and which are having to do their best merely to keep on surviving,” says Russ Mould, investment director at AJ Bell. 

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We take a closer look at what drives sector performance and highlight some current investment trends.

Top investment sectors

Analysis from AJ Bell reveals that some sectors are soaring to all-time highs while others have fallen back in recent years. Some have fallen on account of cyclical pressures – for example the consumer discretionary sector has struggled during the cost-of-living crisis as households cut back on non-essential spending. Others have been out of favour for a little longer.

One thing that is worth noting is that eight of the eleven sectors shown have achieved their peak in the past four years. This is no coincidence – over the long term, stock markets tend to rise more often than they fall, meaning it isn’t particularly rare for markets to reach new heights.

If you can’t decide which sector is likely to outperform over the short or long-term, it might be worth considering a broadly-diversified stock market tracker. By tracking an index like the FTSE 100, the S&P 500 or the MSCI World, you get a little bit of exposure to every sector on the market. This means that you won’t miss out if your sector predictions turn out to be incorrect.

Which sectors are at all-time highs?

Source: AJ Bell as of 3 September. 

What drives sector performance?

There are hundreds of factors that drive sector performance, but interest rates are an important one.

Take UK banks for example – rising interest rates in 2022 and 2023 boosted their earnings overall, as favourable net interest margins meant banks were earning more interest on loans than they were paying out on deposits. Several announced record profits in 2023 and have been paying out generous special dividends to investors. 

But rising interest rates weren’t good news for every sector. UK housebuilders suffered as the cost of borrowing rose and the housing market slumped. Higher interest rates make it more difficult for prospective homeowners to secure a mortgage, so they often spell bad news for the sector.

Interest rates remain high for now, despite the Bank of England making a first cut to the base rate on 1 August. But they should continue to come down (albeit slowly) over the course of the next year or so. While affordability pressures are likely to stick around for some time yet, the outlook for housebuilders looks like it could be starting to turn around.

“If interest rates come down, buyers will be able to borrow more based on the same income, improving volumes and/or prices,” explains Oli Creasey, property research analyst at Quilter Cheviot. “That would flow to housebuilders' bottom lines quite cleanly,” he adds.

But it’s not just interest rates that drive sector performance. Technological innovations also have a big impact, as the development of the Covid vaccine showed in 2020, boosting pharmaceutical and biotech stocks that year and the year after. 

Similarly, structural trends like climate change and demographic shifts are also incredibly influential. An ageing UK population and its impact on sectors like healthcare will be an important one to watch going forward. 

Technology sector: has a bubble emerged?

Investors are closely following the fortunes of the technology sector at the moment, with some expressing concern that it has become overvalued. As recently as July and early August, fears that the AI train might have run out of steam prompted a selloff in the sector. 

Investors remain jittery any time something happens to spook markets. Earlier this week (3 September), chipmaker Nvidia plummeted almost 10% after US manufacturing data came in weaker than expected, raising questions about the strength of the US economy.  

Mould says: “You can see why some investors are nervous about the risk of a bubble in technology, given the sector’s vertiginous rise of the past couple of years and the damage wrought by the last speculative episode.

“That ended with a bang, not a whimper, as J.K. Galbraith once put it, and it took the S&P Global 1200 Technology index more than seventeen years to regain the ground it lost during the carnage of 2000 to 2003, when the bubble burst and valuations (and confidence in the sector) collapsed.”

Keeping an eye on sectors that are at the top of the market is just as important as identifying rising stars, if you think their long-term prospects are about to change. Ideally, you don’t want to be invested in a stock or sector as it comes crashing down, as recovering the potential losses could take time.

When it comes to Big Tech, companies are investing heavily in their AI capabilities, but investors are starting to question whether this constitutes good value for money. Will the returns generated by AI be strong enough to justify the capital expenditure, or is it just hype? 

Going forward, Big Tech companies will have to show they are able to continuously grow their revenues and retain market share, if they want to keep jittery investors on side. 

Do some sectors offer an evergreen opportunity?

Arguably, some sectors offer more of an evergreen opportunity and can act as portfolio stalwarts. Mould says that the ongoing strength in areas like consumer staples and healthcare suggests investors could be “keen to diversify and avoid putting all their faith in the narrative of cooler inflation, a soft economic landing and interest rate cuts”. 

Compare this to luxury brands, which have had a tough time in recent years as consumers struggled with the cost-of-living crisis. Tesla is just one example that we have followed closely at MoneyWeek. The e-vehicle manufacturer has suffered lower sales and delivery numbers as demand in key markets like China has fallen thanks to economic pressures. 

Despite this, investors shouldn’t disregard a sector just because it has fallen out of favour. Seeking out companies which are financially robust but unfashionable could allow you to bag a bargain, hopefully benefitting from share price appreciation when investor sentiment changes. 

For example, the UK equity market in general has been out of favour since Brexit, but recent data suggests sentiment could be starting to shift, with investors now identifying the UK as a place of relative stability. Data released by the Investment Association (IA) today shows that UK equity outflows in July were the lowest they have been all year. 

“July’s UK general election result has created a measure of political certainty, which is helping investor confidence,” says Miranda Seath, director of market insight and fund sectors at the IA. She adds that the government’s commitment to economic growth and fiscal responsibility is a “positive signal for markets”.