Using Sector Rotation Analysis to Uncover New, Under-appreciated Opportunities

One of the things that I’ve learned to do from time to time is to pull back from analyzing individual stocks to take a look at the market from a bigger point of view. I don’t go all the way out to the larger indices, since I look at those about every day just as I do I the stocks I currently have positions in along with my watchlist. Instead, I like to look at the different sectors of the market to see how each of them are moving. This is also known as sector rotation analysis.

“Rotation” refers to the flow of investor money—mostly institutional investors, like investment banks, mutual funds, and insurance companies—from one sector to another. Since average investors like you are me aren’t big enough, even collectively, to influence market movement over time, paying attention to sector rotation provides a good way to track the flow of money from those larger investors that are usually behind the ebb and flow to market activity.

Even in broad bear markets, there are always sectors and industries that will perform better than others, which is why sector rotation can be a useful tool. It isn’t necessary to do this analysis frequently, but when you apply it every few months, it’s a good way to keep your thumb on the broader pulse of the marketplace.

There are several ways to do this analysis. I like to keep it simple. Here’s a chart of all twelve of the sectors listed by Standard & Poors, contrasted against the S&P 500.