Sector rotation is a popular investment strategy that involves “rotating” in and out of different stock market sectors according to economic cycle phases (from expansion to recession). As some sectors are naturally more responsive to economic fluctuations than others, rotating money through different stocks or funds can potentially generate higher returns. For example, cyclical and defensive sectors, including, Finance (XLF), Energy (XLE), and Consumer (XLP) are currently reaching all-time highs.
What exactly is sector rotation?
Sector rotation involves selling out of sectors before periods of indicated poor economic growth and reinvesting those assets into another sector with a better performance outlook, therefore generating higher returns. In the early stages of economic growth, moving into a recovery period following recession, economic activity increases, along with business revenue. During the later stages of the economic cycle, investors tend to rotate out of sectors, such as, consumer discretionary or information technology, because their future growth forecasts tend to be weaker than they are in the economic cycle’s earlier phases. In contrast to a passive investment strategy involving buying and holding an asset for several years, sector rotation is an active strategy requiring close attention and management. So, if you’re looking for a lower-maintenance passive investment, gold bullion, for example, offers lower overall portfolio risk. And, if you’re wondering how much does a gold bar weigh?, rest assured gold bars come in a range of different sizes and weights to suit all budgets.
Sector rotation doesn’t necessarily have to be complex and can simply involve moving between cyclical and defensive stocks. Cyclical sectors generally thrive during times of economic expansion and high consumer demand (retailers, restaurants, and technology companies, for example). On the other hand, defensive sectors are non-cyclical and perform well even during times of economic hardship due to unwaning demand. Defensive sectors include utilities, healthcare, and food producers. A common strategy involves moving from defensive to cyclical stocks when the economy is set for growth and vice versa when economic growth will slow. ETFs (exchange-traded funds) are ideally used in sector rotation investment. These funds are highly-liquid (making it easy to rotate in and out of varying sectors), as well as being affordable and straightforward to deal with.
Sector rotation risks
Sector rotation is inherently risky as there’s the potential to make bad decisions — namely, making a move in anticipation of economic growth, which ends up not happening. This investment strategy therefore demands a proactive, hands-on approach: you need to pay close attention to your portfolio, alongside current general economic activity. Moreover, sector rotation is also volatile. In contrast to a long-term buy-and-hold investment that you keep regardless of market fluctuations, sector rotation increases your exposure to various sectors.
Sector rotation is a popular way to pursue an active investing strategy that promises higher returns. By taking care to make sure it’s the right approach for you, sector rotation may be a smart way to diversify your portfolio.