Sector Rotation Investing: How to Discover the Best Investments in the Stock Market
Sector rotation is the practice of shifting investments through a regular business cycle into sectors that are expected to perform better at each phase of the business cycle. Within each phase of the business cycle there are different economic factors at play and some sectors will prosper while others will struggle. By investing in the strongest sectors of the current phase of each business cycle, industry rotation professionals can significantly increase their investment returns. Instead of investing in the entire stock index, why not invest in the highest performing sectors and earn higher investment gains? Not only do you get higher investment returns, but the process automatically eliminates underperforming sectors of the economy.
The leverage effect of sector turnover
Over time, following a sector strategy in your investment portfolio will have a magical compounding leverage effect. Time is your best friend with this strategy, as you will find that, in the long run, you will avoid investing in underperforming areas of the economy. What this does is create an upward bias in long-term performance results by preventing significant drops in the value of your portfolio. Over time, your portfolio does not have to work as hard as other portfolios fully exposed to the market index.
Bear proof your wallet
Investors have been brainwashed by the mutual fund industry into blindly “buy and hold” investments forever, and stay invested no matter what the stock market or economy is doing. This buy-and-hold strategy has decimated millions of retirement portfolios during the bear market of 2008, and some may never recover their previous portfolio values for the rest of their lives. Why didn’t anyone think to sell stocks and switch to bonds or Treasuries at the start of the bear market? Practitioners of a sector strategy saw capital shift and turnover months before the market began to crash and were able to raise their capital on the safety of margins.
Buy and rotate, not buy and hold
Why cut a market downturn by 50% by buying losing investments? If you do, you’ll need a 100% return on the reduced value of your portfolio just to get back to an initial breakeven. With sector rotation, you never stick with your investment holdings because you know in advance that you will abandon them as soon as trading fundamentals favor better sectors. Once new sectors emerge as market leaders, you simply rotate from your old sectors to the new ones. It’s really that simple.
The Automatic Asset Allocation Effect of Sector Rotation
The real secret to portfolio sector rotation is knowing which asset classes are outperforming the markets. There are several famous studies on asset allocation strategies that have concluded that asset allocation accounts for more than 92% of the success of an investment return. The hidden beauty of a sector rotation strategy is that the process automatically allocates your portfolio holdings to these high-yielding asset classes. Over the long term, these asset allocation decisions will have a powerful effect on the future value of your investment portfolio.
How to get started with sector rotation
Implementing a sector rotation strategy within your own portfolio can be easily accomplished after doing some reading and understanding the 11 core sectors of the economy, the 4 phases of the business cycle, and knowing which sectors perform best in each phase. For those who need a little more confidence, you should read more about how to identify business cycles and which sectors perform best in the Sector Rotation Model. By reading and understanding the basic industry timing model, you’ll see that it’s fairly easy to follow, as it lays out exactly which sectors will perform best during each phase of the business cycle.
Sector rotation is best practiced with a longer investment time horizon in mind and within tax-deferred accounts such as 401Ks, IRAs, Thrift Savings Plans, and Roth IRAs. With a little reading and research, almost anyone can develop a simple sector turnover model. If you’re short on time, there are plenty of free resources and newsletter subscriptions that can give you industry rotation tips to follow.
