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Sector rotation

Sector rotation is the practice of shifting assets from one sector of the economy to another.

Expanded Definition

The term sector rotation can be a misleading one. It can refer to either rotation in the actual economy or rotation from managed money in the markets (sometimes called market rotation).

Many mutual funds, exchange traded funds and institutional investors practice sector rotation and in fact help make it a self fulfilling prophecy. Essentially the idea is that different parts of the economy perform well or are affected by changes in the economy at different times. Supposedly the adroit manager could outperform the market by successfully continually correctly predicting what's going to be hot next. In practice this is much more difficult than it sounds. The lag between cause and effect is not always regular as one would expect, as we will soon see in the example below.

E.g. Let's say that consumer confidence is increasing and that consumers spend more at retailers as a result. The Retailers will see increased earnings due to this spending. They in turn will likely expect to continue this growth and thus buy more inventory from their consumer product vendors ( thus fund managers will now try to rotate into consumer product makers before this happens), the consumer product vendors will buy more raw material producers to make their products (and accordingly the fund managers again try to get into commodities or raw material producers before the "other guy") and this goes on and on in every corner of the economy. The problem for the fund manager is that all her peers knows this as well causing sectors of stocks to move prematurely (due to everybody trying to ditch each other in line) and thus are difficult to predict.

Use to Investors

Sector rotation is a hard game to play, many retail traders who try to follow wall street end up on the losing end of many of their trades. While Wall Street may constantly move funds in and out of stocks based often mercurial reasons in the hopes to be first in and first out, the average longer term investor can benefit by taking advantage of the sometimes dramatic price swings this practice causes in companies with strong fundamentals.

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