Sector rotation is the practice of shifting investments through the course of a regular business cycle into sectors that are expected to perform the best in each phase of the business cycle. Within each phase of the business cycle there are different economic factors at work and some sectors will thrive while others will struggle. By investing in the strongest sectors of the current phase of each economic cycle, practitioners of sector rotation are able to significantly boost their investment returns. Instead of investing in the entire stock market index, why not invest in the top performing sectors and harvest greater investment gains? Not only are greater investment gains made, but the process automatically weeds out poor performing sectors of the economy.
The Leverage Effect of Sector Rotation
Over time, following a sector strategy in your investment portfolio will have a magical compounding leverage effect. Time is your greatest friend with this strategy as you will find that in the long run you will avoid making investments in poor performing areas of the economy. What this does is creates an upward bias to your long run performance results by avoiding any significant declines in your portfolio value. Over time, your portfolio does not have to work as hard as other portfolios fully exposed to the market index.
Bear Proof Your Portfolio
The mutual fund industry has brainwashed investors to just blindly “buy and hold” investments forever, and to 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 2008 bear market, and some may never recover their past portfolio values for the rest of their lifetime. Why didn’t anyone think to sell equities and shift into bonds or treasuries at the start of the bear market? Practitioners of a sector strategy saw the shift and rotation of capital months before the market started to crash and were able to get their capital onto the safety of the sidelines.
Buy and Rotate, Not Buy and Hold
Why ride down a market decline by 50% buy holding losing investments? If you do that, it will take a 100% return on your shrunken portfolio value just to get back to a break-even starting point. With sector rotation you never get attached to your investment holdings because you know in advance you will be exiting them as soon as the business fundamentals favor better sectors. Once new sectors emerge as market leaders you simply rotate out of your old sectors and into the new ones. It really is that simple.
The Automatic Asset Allocation Effect of Sector Rotation
The real secret of portfolio sector rotation is knowing what asset classes are outperforming the markets. There are several famous studies on asset allocation strategies that have concluded that asset allocation accounts for over 92% of an investments performance success. The hidden beauty of a sector rotation strategy is that the process automatically allocates your portfolio holdings into these top performing asset classes. Over the long run these asset allocation decisions will have a powerful effect on the future value of your investment portfolio.
How to Started with Sector Rotation
Implementing a sector rotation strategy inside your own portfolio can be easily achieved after a little reading and understanding of the 11 basic sectors in the economy, the 4 phases of the business cycle, and knowing which sectors perform best in each phase. For those that need a little more confidence you should read more about how to identify the business cycles and which sectors perform best in the Sector Rotation Model. By reading and understanding the basic sector timing model you will see it is quite easy to follow as it lays out exactly which sectors will perform the best during each phase of the business cycle.
Sector rotation is best practiced with a longer investment time horizon in mind, and inside tax deferred accounts like 401Ks, IRAs, Thrift Savings Plans, and Roth IRAs. With a little reading and research almost anyone can develop a simple sector rotation model. If you don’t have the time there are many free resources and newsletter subscriptions that can offer sector rotation advice to follow.