The investing strategy of sector rotation is based on the principle that during different periods in the economic cycle different sectors will benefit the most. This is mostly practiced by large fund and portfolio managers in order for them to try to outperform the market.
The economic cycle can be split into four stages:
This occurs after a recession. During the early stages of a recovery from a recession you may see that transportation companies are seeing more profits and they are starting to move around more products to market. Auto manufacturers who have been crushed to near bankruptcy are recovering. The industrial sector starts to pick up. As growth starts to emerge from the ruins good sectors to potentially invest in are recruitment, recovering industrial conglomerates that have avoided bankruptcy and technology.
Late Recovery (Boom Time)
During this period the world is a great place for stocks, the consumer is in buying mode and consumer durables and technology are doing well. Retailers (online and offline) are seeing huge demand and lending is increasing.
Growth is starting to slow down and the pace of expansion cannot continue. The move to more secure investment categories starts to happen. Bonds come back into favor and the business sectors that may see improved performance are utilities (water, gas, electricity) and certain cyclical industries.
Full Recession (Bust)
In a full recession the economy is bad, unemployment is higher and interest rates are being reduced to stimulate growth. During the bust it is best to not be in stocks. But if you feel you must, good sectors are those that provide the good people cannot live without such as food, heating, energy, health.
Can provide some shielding against the economic ups and downs.
You really need to understand economics and have a good grasp of where the economy is in the business cycle.
Even if you practice sector rotation is does not mean it will be successful or that you will select the best company or vehicles to invest in.
Average trade duration
1-2 years per rotation
Effort to maintain the strategy
High – constantly evaluation the economic situation and having a good grasp of all tools and companies can be time consuming.