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Sector Rotation Strategy - A Guide for the DIY Investor |
Sector Rotation
> Sector Rotation Strategy
A Sector Rotation Strategy for the DIY Investor
Here
we put all the pieces of a sector rotation strategy together
in an
easy to follow step-by-step guide so any DIY investor can read the
economic and fundamental clues ocurring in the business cycle and
position their own investment portfolio to benefit from sector
rotation. Regardless of your investment knowledge or
experience,
after a little reading and research you should be able to follow and
implement this basic strategy.
All you need to do is be able
to
read the clues of what the economy is doing and where it is expected to
go. Follow these simple datapoints that can be found in the
daily
business section of any newspaper to get your strategy started today.
DIY Sector ETF Investing
Why pay high fees, subject yourself to below average returns, and get
boxed in with minimum investment purchase amounts?
We are convinced that almost anyone can generate better
returns than most of the professionally managed sector rotation funds
with a little research and a few hours per month. Our
preferred investment vehicle is Sector ETFs, and with a
little homework and research you could implement a DIY sector
rotation strategy.
Resources You Will Need
Like
any DIY project you will need to gather the necessary
resources to
propery implement a sector rotation strategy based on fundamental
analysis of economic and business data. Here is a list of
what
you will need:
- Computer and Internet connection
- Business section of a major city newspaper
- A brokerage account
- Stock Charting Program
Step 1 - Assess Consumer Expectations
What are consumer expectations doing right now? How do
consumers feel about the economy and their economic
livelihood? In good times consumers have disposable income to
spend, feel good about their future economic prospects, and tend to
spend money like it will always be there for them. This has
the effect of driving higher GDP in the economy. Reading a
business newspaper like the Wall Street Journal will give you a pretty
clear picture of consumer expectations.
Step 2 - Assess Industrial Production Levels
What level is industrial production at in relation to its business
cycle? Is production at full capacity or is it
idle? Businesses behave in a similar fashion to consumers
about their business expectations - when times are good and business is
expanding with strong profits they tend to spend more on expanding
production and facilities. Conversely, when times are tough
businesses pull back on spending, create layoffs, and reduce their
expenditures. This has the effect of lowering GDP in the
economy. Reading a business newspaper like the Wall Street
Journal will give you a pretty clear picture of industrial production
levels and their outlook.
Step 3 - Assess Interest Rate Trends
What are interest rates doing right now? What is
the spread between short-term interest rates and long-term interest
rates? What is the trend in interest rate changes?
Rising interest rates generally indicate a growing economy, and
lowering interest rates generally indicate a cooling economy.
The Wall Street Journal usually has a detailed section on
interest rates and will often chart the history of interest rates so
you can see what trend is developing.
Step 4 - Examine the Yield Curve
What is the slope of the yield curve which charts short term and long
term interest rates? In a healthy economy the yield curve has
a positive slope as lenders providing capital for longer periods of
time expect a higher interest rate to account for the additional risk
and time involved. Conversely, if the yield curve is inverted
where short term rates are higher than long term rates, this generally
implies that the bond market is predicting lower future interest rates
and a possible recession. The Wall Street Journal or any
other newspaper will usually have a graph of the current yield curve.
Step 5 - Determine the Current Stage of Business Cycle
Based on your observations in steps 1 - 4, use the Sector
Rotation Model to determine which sectors are
most likely to benefit in current business cycle environment.
Step 6 - Place your Sector Trades
Position your portfolio with some weighting to the sectors you have
determined will benefit the most from the next stage of the economic
cycle. Bear in mind that shifts between cycle phases can often be long
and drawn out, with no clear distinguishing line to determine when one
phase ends and another begins. Chances are your investment
timing may be early, sometimes by many months, or it could be late.
It will all depend upon your ability to read the economic
cycle clues, and the actual cycle transitions themselves.
Some are long and drawn out, while others are so quick you
can miss them.
Step 7 - Monitor Economic Signals and Repeat Steps 1 - 6 When
Necessary
Successful sector rotation takes vigilance and constant monitoring of
economic trends and statistics. As these business statistics
change, they may be signaling that another cycle change is under way.
You will need to read the business newspapers daily or weekly
to stay on top of economic trends, as your sector investments are
leading indicators and will be interpreting and responding daily to the
unfolding economic news.
The Pitfalls and Downside of DIY Sector Rotation Based on
Fundamental Analysis
 If
this is so easy why isn't everyone doing it? Well
in theory it
sounds simple enough, but like most things in life once you try to
implement them in real-world situtations everything becomes much less
clear. Real life will create situations that the model does
not
handle well, or it will take a lot longer to play out than anticipated.
What if you are 12 months too early into the next rotation
trade?
Or what if you miss the trade by 5 months? Here
are some
of the pitfalls of using fundamental analysis as the basis for a sector
rotation strategy:
Problem Determining Stage of Business Cycle
Its often not clear what stage of the economic cycle we are in, and the
transition from each phase of the cycle can take many months to unfold.
Do you invest early, or wait for confimation of sector
movement before entering the trade?
Economic Signals Do Not Match Model
Sometimes the economic statistics and signals are false starts, or the
results do not match the theory of the sector rotation model.
Not everything will line up in neat and tidy rows to allow
you to clearly determing a shift in the business cycle. Its a
running joke in economic circles that most economists cannot even agree
on the interpretation of much of the published economic data.
Trading Sectors Too Early
There is a risk that you enter a sector trade much to early and expose
your capital to losses, or your capital sits idle for many months or
even years while you wait for the sector trade to respond to the next
phase of the economic business cycle.
Trading Sectors Too Late
There is a risk that you miss the sector trade as the business cycle
has shifted a lot faster than anticipated, and the sector indexes have
already fully priced in the next cycle into their valuations.
It Takes a Lot of Time and Energy
Fundamental analysis of business and economic cycles takes constant
monitoring and a lot of your time. If you miss following the
economic data you may miss the signs of the next cycle shift underway.
If only there
was an easier way that did not involve so much time and energy...
Luckily We've Fixed the Problems with Fundamental Sector
Rotation Analysis!
 Luckily
we have discovered a simply way to
time the rotation underlying the economic cycle using leading
indicators that anticipate the cycle rotation before it actually
occurs.
With this method you don't focus on lagging
economic data, but on what the leading indicator sectors are
telling us. By concentrating on these leading indicators we
narrow the focus of timing like a laser beam and never miss the next
sectors starting to breaking out...
Up next:
Discover the Next
Generation of Sector Rotation Investing
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