What Is Sector Rotation?
A sector rotation investment strategy is a powerful tool for investors.
I’m sure you’ve seen this chart before…
It shows how the economic cycle and the market behave at different times. And which sectors of the market tend to outperform during each stage of the cycle.
What is the Business Cycle?
The business cycle is generally thought of as changes in the pace of economic growth. There are four phases of the business cycle… trough, recovery, peak, and contraction.
In today’s economy, these fluctuations occur around a long-term growth trend.
The economy moves through periods of rapid economic growth as well as periods of stagnation. These cycles can quickly change from month to month or quarter to quarter.
Most people only notice these fluctuations when one of the periods of economic stagnation snowballs into a period of contraction or recession.
But the pace of economic growth is constantly moving through periods of acceleration and deceleration.
What is Sector Rotation?
As the economy moves through the business cycle, each phase has different economic fundamentals that impact sectors of the economy in different ways.
Some sectors perform well in times of rapid expansion. Other sectors perform better when the economy is going through periods of stagnation.
Sector rotation takes advantage of these cycles.
Simply put, sector rotation means investing in the sectors of the economy that typically perform the best during that phase of the business cycle. This requires changing your investments as the business cycle moves from one phase to the next.
Analyzing A Sector Rotation Strategy
Understanding the business cycle and that different sectors of the economy tend to do better in different phases of the economy is the foundation of sector rotation.
But implementing a sector rotation strategy in the real world is easier said than done.
There aren’t any big announcements telling you, hey, the economy is moving from a period of acceleration into a period of decelerating growth so everyone rotate.
In fact, pinning down the business cycle is hard to do in real time. It’s much easier to do in the rearview mirror. You can go back and look at changes in GDP growth rates and see the inflection points.
In order to pinpoint changes in the business cycle on the fly, we use economic data points. Things like consumer expectations, interest rates, industrial production, employment, inflation, and hundreds more give us a glimpse into the future.
Analyzing and understanding what they mean gives us the tools to make predictions about changes in the business cycle. Then you can align your sector rotation strategy with the best performing investments for that stage of the cycle.
That’s sector rotation in a nutshell…
Next time we’ll take a look at the 9 US sectors and some different ways you can implement a sector rotation strategy.
Good Investing,
Corey Williams
ETF Trading Research
Note: Corey Williams writes and edits ETFTradingResearch.com. Sign up for our free ETF reports and free e-letter at http://www.etftradingresearch.com/free-sign-up. We’re devoted to helping you make more money from ETFs.
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