A simple view of sector rotation


Continuing when my previous post here, market cycles leads economic cycle. This article aims to give a brief descriptive (not predictive) overview of how asset managers shift their exposure to sectors – according to the current style of investment, say, growth strategy – where expectations of future earnings revision are very positive – or in defensive strategy – where sectors are the next alternative to a somethings considered “risk-free” and they can remain invested while less vulnerable (still vulnerable, since correlation breakdowns when the market is in turmoil) – or value strategies – where sector is undervalued or in anther words, the expected risk premium has subside due to fading risk factors.

However, one difficulty is that one style of investment can permeate across more than one sector. For instance, one would argue that the current growth strategy might be fading over to a more sustainable value strategy, given that the catalyst for growth to materialise might be a flop. So if one were to research for undervalued assets, these assets could span across sectors – it could be discretionary, energy or financials. For now, I will benchmark sector performance against the market to see which sector is under or out performing the entire market.

Systematic risk, also known as “market risk” or “un-diversifiable risk“, is the uncertainty inherent to the entire market or entire market segment. Also referred to as volatility, systematic risk consists of the day-to-day fluctuations in a stock’s price.

Unsystematic risk, also known as “specific risk,” “diversifiable risk” or “residual risk,” is the type of uncertainty that comes with the company or industry you invest in. Unsystematic risk can be reduced through diversification.

Metrics used are sector price / market price (known as relative strength used as a guideline to identify cyclical patterns, but nowhere clear for use as trading signals),

rolling Beta = systematic risk or sensitivity to market risk (used as hedge ratio against benchmark i.e. more sensitive requires more buffer),

rolling Alpha = excess return from sector uncorrelated with systematic (market) return. We want to be exposed to upcoming Alpha rather than diversify these alpha away. We will allocate to sectors where alpha is likely to grow or remain positive.

All metrics used are historical not forward and have no predictive value. But it does tell us where we stand as now. Data used are from Quandl and tickers used are:


Relative Strength – how the sector is performing against the market?


Source: Quandl, Python

From image shown above, healthcare, staples and utilities (defensive sectors as shown below in appendix) have been out of favor. Surprisingly, discretionary also tagged along with the defensive sector as well. Energy, materials and industrial pick up on expectations of fiscal stimulus materialsing. Financials remain very depressed. But what will happen if Trump repeals Volcker Rule?


Source: Quandl, Python

Alpha – which sector had generated excess return over systematic market returns?

Materials, Financial and Industrial


Source: Quandl, Python


Source: Quandl, Python


  • discretionary and technology sensitive to market moves
  • utilities from positive to negative beta
  • healthcare is now positive beta
  • discretionary is at positive beta high


Appendix: Sectors cyclical behaviour against SPX from 2005-2017

  • discretionary and technology are the main driver of SPX direction, given technology has 21.3% weightage in SPX


  • discretionary/utilities fits SPX moves closely – reason: discretionary is a proxy of retail purchasing power, high employment rate, and economic growth
  • Note that before 2007-2008 crisis, discretionary companies have been reporting falling net profits such that it underperformed since 2005-2008
  • caution: discretionary not able to outperform against other sectors which is a cause of concern especially when SPX is still into trump’s promise
  • materials to outperform staples soon as it breaks a long term down trend



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