Sector rotation is a theory of
stock market
A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include ''securities'' listed on a public stock exchange, as ...
trading patterns.
In this context, a
sector
Sector may refer to:
Places
* Sector, West Virginia, U.S.
Geometry
* Circular sector, the portion of a disc enclosed by two radii and a circular arc
* Hyperbolic sector, a region enclosed by two radii and a hyperbolic arc
* Spherical sector, a po ...
is understood to mean a group of stocks representing companies in similar lines of business.
The basic premise is that these stocks can be expected to perform similarly. Additionally, different groups of stocks which have been clustered according to the aforementioned principle will show differing performance.
Sector rotation theory says a number of things. First, whichever sector is hot (has done well recently) should continue to outperform. Second, these sectors will eventually rotate so that whatever was once out of favor will be in favor. Third, these movements are somewhat predictable, and connected with the
business cycle
Business cycles are intervals of Economic expansion, expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are ...
.
With the phase-shift in the performance cycle of sectors (ideally like the
phase-shift
In physics and mathematics, the phase of a periodic function F of some real variable t (such as time) is an angle-like quantity representing the fraction of the cycle covered up to t. It is denoted \phi(t) and expressed in such a scale that it ...
ed wave patterns of
three-phase electric power
Three-phase electric power (abbreviated 3φ) is a common type of alternating current used in electricity generation, transmission, and distribution. It is a type of polyphase system employing three wires (or four including an optional neutral ...
) an investor could continually hop from a sector at the peak of performance to a sector showing a potential to rise.
A sector rotation investment strategy is not a passive investment strategy like indexing, and requires periodic review and adjustment of sector holdings.
Tactical asset allocation
Tactical asset allocation (TAA) is a dynamic investment strategy that actively adjusts a portfolio's asset allocation. The goal of a TAA strategy is to improve the risk-adjusted returns of passive management investing.
Strategy descriptions
TAA ...
and sector rotation strategies require patience and discipline, but have the potential to outperform passive indexing investment strategies.
Examples
An investor or trader may describe the current market movements as favoring
basic material
Building material is material used for construction. Many naturally occurring substances, such as clay, rocks, sand, wood, and even twigs and leaves, have been used to construct buildings. Apart from naturally occurring materials, many man-mad ...
stocks over
semiconductor
A semiconductor is a material which has an electrical resistivity and conductivity, electrical conductivity value falling between that of a electrical conductor, conductor, such as copper, and an insulator (electricity), insulator, such as glas ...
stocks by calling the environment a sector rotation from semiconductors to basic materials.
An example of a sector clustering would be:
; Leading
: This includes stocks like consumer cyclicals and financial companies. These would do well when the market is at its bottom.
; In-line
: This includes stocks like technology and telecommunication. These should outperform the overall market in the main part of a bull market.
; Lagging
: This includes stocks like energy companies. These would perform well when the market is at its top.
; Contrarian
: This includes consumer staples. These should perform least badly in a bear market.
Note that the performances mentioned are always relative to the overall market. During a bear market it is expected that all stocks will go down some.
Connection with other markets
The primary driver of sector rotation is the variability of
currency
A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins.
A more general def ...
values (inflationary, disinflationary, or deflationary) and interest rates. As the economy expands, demand for raw materials creates inflationary pressures, which in turn prompt higher interest rates, which increase the value of the currency, which reduces the competitiveness of a country's exports as the currency causes them to cost more to other countries. This final stage causes the economy to contract, reducing demand for raw materials, which creates deflationary pressures, which in turn prompt lower interest rates, which decrease the value of the currency, which increases the competitiveness of a country's exports—creating a new market cycle. The relative strength of commodities, bonds, currencies, and stocks shift in this changing monetary climate in a somewhat predictable manner.
[John Murphy, Intermarket Analysis, pp. 183-184.]
Saying
"The worst house in a good neighborhood is better than the best house in a bad neighborhood."
See also
*
Style investing Style investing is an investment approach in which securities are grouped into categories and portfolio allocation based on selection among styles rather than among individual securities. Style investors can make portfolio allocation decisions by pl ...
References
*
External links
{{DEFAULTSORT:Sector Rotation
Stock market