Totaling the car over a flat tire – Sector Rotation a Big Picture Look
Your faithful car still runs well and is in good shape. This is despite the ding in the door from the runaway shopping cart and that crayon mark on the backseat from your child’s attempt to “fix” it. One morning, while driving your faithful car, you get a flat tire after hitting a pothole. Time for a new car? We are fairly certain you wouldn’t throw your hands up, declare your faithful car a total loss and buy a new one.
When news about the stock market is “bad”, and the numbers support it, we believe playing defense is a good plan. In this case, would you throw your hands up and sell all of your equities to cash, only to wait for a sign to show you that everything is peachy so you can buy back into the market? This seems like a bit of an overreaction. Not to mention there were likely some equities in your portfolio with decent performance – why get rid of them?
So now the question becomes: How do you identify what to sell and what to keep? This is where sector rotation comes in. If you break the equity market down into segments, by industry, size, country, etc., you can track and rank these sectors individually and identify which are outperforming or underperforming the others. If a sector is falling in ranking and another is rising, rotating out of the one that is falling into the one that is rising is like fixing the flat tire instead of selling the car. Another benefit of this strategy is it allows you to let those sectors that are really outpacing the rest to continue to grow – just a few sectors that are doing significantly better than the others can have a big impact on your portfolio.
This image is from one of our monthly seminars. It is an example from a few years ago highlighting the change in ranking of two specific sectors over a 4-month period. Notice the change in ranking for Small-Cap US stocks and All US Fixed Income Quality (bonds). Since small-caps were falling and bonds were rising, would it have made sense to sell all your equities and move to bonds?
Look at what stayed in the top 10 – a sector rotation strategy may have allowed you to keep your internet, emerging markets and real estate holdings, and move only those sectors which were going out of favor.
Sector rotation, like all investment strategies is not a perfect science; however, we believe that by adding it to your portfolio management toolkit you may be able to be a bit more selective with your defensive moves and strategic with your offensive ones.