The Sector Rotation Theory

We had pubished an article in this blog on 9th May 2009. This article on "Identifying a Bull Market" discusses about various sectors that perform at various stages of market cycle. It is worth reading this article again, TAKE A CLOSE LOOK AT YOUR PORTFOLIO and MAKE SUITABLE SECTOR ROTATION TO MAXIMIZE RETURNS. Click here to read it.

The above mentioned article is based on "The sector rotation model", credited to Sam Stovall of Standard & Poor’s, assumes that the economy follows a well-defined economic cycle and further states that different sectors tend to perform better in different phases of the cycle.

In a nutshell, what the model emphasizes is that the first phase of the cycle is characterized by easy monetary policy and a revival in consumer spending. Interest rate-sensitive companies and consumer facing groups thus tend to do well in the initial phase of a bull market. This is also a phase where the more aggressive consumer discretionary space starts outperforming the more defensive consumer staples. Financials, being interest rate sensitive, show their best performance in this phase.

This then gives way to good performance by Technology stocks.

Later in the cycle, one sees that improved consumer spending slowly eats into inventories and leads to higher capital utilization. This eventually leads to higher capital expenditure and greater demand for capital goods. Also, in this last phase of expansion, which is highly inflationary, commodities start performing very well.

Towards the end of this last phase of expansion and the beginning of the contraction phase, the defensive appeal of Consumer Staples kicks in and they become the best performing group along with Utilities.