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Sector Rotation: The Essentials
If you've spent any time at all following financial markets, you've probably heard of sector rotation. Certain sectors of business profit more in certain stages of an economic cycle. This simple arrangement of stages provides a useful road map to traders of most stripes. Here, we'll look at the basic sectors of the economy and the telltale signs of each economic stage.
Tutorial: Economic Indicators What Is Sector Rotation? Sector rotation is an investment strategy involving the movement of money from one industry sector to another in an attempt to beat the market. It sprouted as a theory from National Bureau of Economic Research (NBER) data on economic cycles dating back to 1854. It's thanks to this cadre of government and academic economists that we know the start, end, and duration of each business cycle. (For more insight, read Market Cycles: The Key To Maximum Returns.)
You may have heard of the NBER before: they're the ones that announce that a recession has officially ended - three years after the fact. The data may be slow to develop, and a bit dry, but a little digging can provide insight that investors can use to make decisions. It's important to remember that past performance in the stock market does not always mean future success, and a particular sector may, or may not, be in favor at any time.
That said, let's look at the data that can help investors decide what they should be invested in during any given market cycle.
Market Cycle in Four Stages Markets moves up and down just like the economy. For the purpose of this discussion, we will divide that cycle into four stages:
• Market bottom - This is represented by diving prices, culminating in a long-term low.
• Bull market - This begins as the market rallies from the market bottom.
• Market top - Just as it sounds, this stage hits the top as the bull market starts to flatten out.
• Bear market - Here we go down again. This is the precursor to the next market bottom.
Most of the time, financial markets attempt to predict the state of the economy, anywhere from three to six months into the future. That means the market cycle is usually well ahead of the economic cycle.This is crucial to remember because as the economy is in the pits of a recession, the market begins to look ahead to a recovery. Economic Cycle in Four Stages Here is a list, in the same order as above, of four basic stages of the economic cycle, and some associated telltale signs - again, keep in mind that these usually trail the market cycle by a few months.
• Full Recession This is not a good time for businesses or the unemployed. GDP has been retracting, quarter-over-quarter, interest rates are falling, consumer expectations have bottomed and the yield curve is normal. Sectors that have historically profited most in this stage include:
• Cyclicals and transports (near the beginning)
• Technology
• Industrials (near the end)
• Early Recovery This is when things start to pick up. Consumer expectations are rising, industrial production is growing, interest rates have bottomed and the yield curve is beginning to get steeper.
Historically, successful sectors at this stage include:
• Industrials (near the beginning)
• Basic materials
• Energy (near the end)
• Late Recovery In this stage, interest rates can be rising rapidly, with a flattening yield curve.Consumer expectations are beginning to decline, and industrial production is flat. Historically profitable sectors in this stage include:
• Energy (near the beginning)
• Staples
• Services (near the end)
Early Recession This is where things start to go bad for the overall economy. Consumer expectations are at their worst, industrial production is falling, interest rates are at their highest, and the yield curve is flat or even inverted. Historically, the following sectors have found favor during these rough times:
• Services (near the beginning)
• Utilities
• Cyclicals and transports (near the end)
The Bottom line With this general outline in mind, traders can try to anticipate which companies will be successful in the coming stages of an economic cycle. Equally important can be the signs the market is exhibiting on future economic conditions. Watching for these telltale signs can give great insight into which stage traders believe the economy is in.
Smart Choice is for informational and educational purposes only.
Feel free to contact me at; mgreen@tgacapitalmanagement.com and visit our website for more detailed information and to join our weekly, monthly newsletters. Our website resources are currently available without any obligation and we hope it helps you to make a smart choice.
Sincerely,
Michael D. Green, Principal
TGA Capital Management.Com
25 Braintree Hill Office Park
Braintree, MA 02184
A Registered Investment Advisory, RIA
Mgreen@tgacapitalmanagement.com
https://www.linkedin.com/in/tgagiacapitalmanagement
1.508.224.9646
This is not a solicitation nor recommendation to buy or sell a securities nor to imply any tax or legal advice, always seek a registered investment advisor to attain your risk/averse attitude and investment suitability before investing. All information is considered accurate and reliable, however, due to changing market, economic, taxation, institutional, and other pertinent potential cycles and variations, future results cannot be guaranteed by past performance and should be monitored on a continual periodic systematic basis to provide current advisory recommendations that meets the client short-term potential deviations and management disciplined style, while advisory provides solely long-term recommendations.
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