At one level, a sector rotation approach may seem similar to market timing, or moving into and out of investments to make quick money on very short-term gains. Individual investors are generally urged to avoid timing their trades on the grounds that losses are much more common than gains, especially when trading costs are taken into account. But that’s not necessarily the case with sector rotation.
One difference is that speed isn’t typically essential, as the period in which a sector gains ground may be measured in months rather than in minutes or less. Another difference is that the rotation strategy is based on years of research that documents the various points in an economic cycle when specific types of businesses have tended to profit the most. A third is that sector rotation is often part of an asset allocation strategy, in which you designate a specific, limited percentage of your portfolio for timely investment.
What these strategies do have in common, though, is that they depend on buying and selling at the right time, which you can know for sure only after the fact. And a sector’s time in the sun can be brief, which means that if you’re not invested at the bottom and don’t get out at the top, you could lose as much or more than you gained. For instance, in 2001, utilities, which had outshown the competition the year before, dropped 26% in value.
A different approach
There’s a simpler, less research-driven approach to sector rotation that involves choosing investments that seem likely to be bolstered by cyclical consumer behavior rather than what’s happening in the economy. Using this approach, you invest in retail stocks in the period before the Christmas holiday and in travel-related stocks before the summer vacation period.
The problem, though, is that it doesn’t always work — often for reasons that are driven by particular market forces like an impending recession or an increase in the price of oil.
