Are you familiar with the term “sector rotation?” Sector rotation is when a portfolio manager shifts from one asset class to another. There are numerous reasons to perform sector rotation. To name a few: seasonal trends (holidays, back to school, driving season, new quarter, etc..), political factors (a new law gets passed, the Fed changes its monetary stance), outperformance to underperformance (a big rally in a certain sector causes managers to look elsewhere for gains or vise versa), etc.. The key to profiting off of sector rotation is recognizing when it is occurring.
Being that this week brought the start of a new quarter, we believe we might be observing some sector rotation right now. We’re going to start by analyzing the year to date gains seen in key sector ETF’s to determine what sectors have performed well so far in 2012:
- XLF (financials) up 19.8% ytd
- XLK (technology) up 17.6%
- XLY (consumer discretionary) up 14.6%
- XLI (industrials) up 10.8%
- XLB (materials) up 10%
- XLV (healthcare) up 8.7%
- XLP (consumer staples) up 5.5%
- XLE (energy) up 2.7%
- XLU (utilities) down 1.6%
As you can see, financials & technology have been by far the best performing sectors of 2012, with consumer discretionary not far behind. Industrials, materials, & healthcare have performed solid. Meanwhile, consumer staples, energy, and utilities, have all lagged behind. Now let’s compare the lows in these ETF’s seen this week (first week of Q2), to their lows from last week (last week of Q1) – % difference in ():
- XLF – $15.57 last week vs $15.51 this week (-0.038%)
- XLK – $30.03 vs $29.91 (-0.04%)
- XLY – $44.39 vs $44.42 (0.006%)
- XLI – $36.75 vs $36.95 (0.054%)
- XLB – $36.33 vs $36.48 (0.004%)
- XLV – $36.81 vs $37.43 (1.68%)
- XLP – $33.64 vs $33.98 (1.0%)
- XLE – $70.17 vs $70.53 (0.05%)
- XLU – $34.39 vs $34.93 (1.6%)
Do you notice what we notice? The two sectors that performed the best in Q1, have performed the worst vs their lows from last week so far this week. Meanwhile, the four sectors that performed the worst in Q1 have held up better this week vs their lows from last week. In addition, materials and industrials, which performed good but not great, are also holding up better vs their lows from last week during the market weakness.
This is a subtle, but potentially very meaningful point to make note of. This could suggest that we are in the early stages of sector rotation that sees portfolio managers allocating more of their funds to those sectors that underperformed so far in 2012 and away from the sectors that outperformed. We still need more evidence in the form of outperformance from these previous underperforming or “in line” sectors to signal that that’s what’s going on right now but the key is to start thinking about it now. Early birds get the worm, but traders who notice things like this early get the profits.
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