What are the most common sector rotation strategies for traders?

In todays world governments are becoming bigger part of their own GDP and reallocating the capital depending upon their priorities. The average govt expenditure as % of GDP in G-7 is close to 40% and with their focus on bringing back supply chains and reindustrialisation I would just recommend to follow govt policies closely as they are deciding winners and losers in this Brave new world.

Though business cycle approach has performed remarkably well during past recessions where defensives like Consumer Staples and Utilities have outperformed the cyclical sectors of the economy, however there has been a complete change in how investors perceive “defensives” today. Cash rich companies with healthy return ratios and sustainable Cash Flows are today preferred over the conventional approach of picking up sectors during business cycle. The safe haven appeal of the Mag 7 can also be attributed to their dominant position in the businesses that they are into. As a result, though business cycle approach might work this time but the alternatives are emerging.

Money do not stay at one place. Its jumps from one sector to the other. One must know how sectors are corelated. Lets understand by an example: Steel prices rise, Metal Sector booms. Auto companies buy metals at a higher rate, Automobiles become expensive, they get a sale decline, Auto sector falls. Meaning, when metal sector is up, Auto sector is down and vice versa. Similarly, 1. When IT rises, Banks are down or sideways. 2. When Pharma sector rises, majority of the other sectors are down or sideways. 3. When cement sector rises, realty/infrastructure is down or sideways.

The business Cycle approach is a more macroeconomic approach with an understanding of how liquidity flows and how government policies, interest rates, inflation, and socio-economic behavior affect the different sectors. It can be accompanied by technical analysis for picking the entry and exit points in the trade, and how the price is factoring all the information. But the most important factor here to consider is the flow of liquidity between sectors. In a high-inflation environment, you will see Commodities outperforming and sector like FMCG industrial goods getting their margin affected due to increased raw material costs due to high commodities prices.

1. Economic Cycle Rotation: Investors shift between sectors based on different stages of the economic cycle. For example, cyclicals (e.g., technology, consumer discretionary) may perform well during economic expansion, while defensives (e.g., utilities, healthcare) may be favored during economic downturns. 2. Tactical Rotation: This involves adapting to short-term market conditions. Traders may rotate to sectors showing resilience during market volatility or economic uncertainties. 3. Interest Rate Sensitivity Rotation: Sectors respond differently to interest rate changes. Traders may rotate into or out of sectors based on expectations of interest rate movements.

Relative strength measures the performance of a particular sector to the whole market or it can be measured against another sector, based on the approach. A sector with high Relative strength (rating above 90) generally outperforms all the other sectors. If you are a momentum trader/ investor you would like to stay in sectors which a high RS rating. RS rating can be combined with Fundamental factors like EPS growth and earnings growth and can also consider the whole sector growth. You can read books of Mark Minervinie to understand how to combine RS and Fundamental factors to make a robust trading system

A good way to look at relative strength of Sectors is Ratio charts. For instance, if one is looking at Pharmaceuticals in India, she/he may plot the following ratio - NSE Pharma index ÷ Nifty 50 index Adding a regression channel with SD (+/- 1 and 2) helps in putting things in perspective over long market cycles. I have personally found it more useful than other approaches. For instance, ratio charts of sectors like Infrastructure, Industrials, Automobiles, PSU banks in India gave signs of recovery pretty early in the cycle.

Growth Rotation: This strategy involves rotating investments among sectors that are expected to experience above-average growth rates. It often involves shifting investments from mature sectors to those with high growth potential, such as technology, healthcare, or consumer discretionary.

Each sector has a capital cycle followed by sales cycle. One needs to be aware of this switch of context as it happens. It is at this switch where value exists and growth for which capital stands infused is yet to be priced.

Currently, macroenvironment is playing a great role. Fundamentally strong companies are easy trade as they move when market moves due to one or the other macroenvironment factor. Trades have been easier for Mag-7 companies for the past year and so. There were opportunities everywhere.