Factors Outside the Business Cycle

In addition to evaluating sector performance relative to the business cycle, it is important to evaluate factors that are external to the business cycle, as they can also influence the short- or long-term behavior of various industries' stocks. Some of these factors include:

Government policies. Recent examples include high-tech antitrust cases such as Microsoft*, the auction of radio frequencies, initiatives to reform healthcare, and the approval or denial of new biotech product proposals.

International trade and competition. The increasing globalization of the economy means that foreign activities can affect American markets. For example, China's move toward acceptance as a member of the World Trade Organization could have a major impact on U.S. exports. Industries that are sensitive to imports or exports will also be affected by changes in currency values.

International exposure. When evaluating sector funds, it is also important to keep in mind that certain sector funds may invest in foreign securities. Similar to any mutual fund, a sector fund's exposure to international securities could magnify the overall risk of the fund. For example, foreign government regulation in the healthcare sector. While some drug companies have benefited by government deregulation, heavily regulated pricing and government bureaucracy have hampered others.

Consumer demand. While some aspects of demand are tied to the business cycle, demand can also follow changes in demographics, fashions, price levels, or cultural concerns. Strong holiday sales (or the expectation of them) can send retail stocks up. During the late 1990s, the emergence of the Internet and the demand for access created new markets for Internet service providers and online retailers.

Innovation. The introduction of new products and technologies can change the entire landscape of an industry. Examples include the booming trend toward wireless communication and developments in biotechnology. While great investment opportunities abound, rapid product development can also lead to the obsolescence of established products.

• *These materials, including references to specific companies, are for informational purposes only and should not be construed as recommendations.