Why Sector Rotation Is An Opportunity
October 18, 2020 Updated October 10, 2023
Takeaways
What is a sector rotation
Why a first mover profits the most
How to handle a sector rotation
What is a sector rotation?
A sector rotation is selling or reducing your exposure to one sector of the stock market, and investing your proceeds into another. This can because you are banking some gains, or because the investment case is no longer valid. You should be aware of such flows of money, as it helps to ride momentum.
In the early 20th century, technology stocks were seen as the place to be to get a superior return. Over time as many investors followed suit, the 'tech trade' became over crowded and the valuations were out of sync with any form of reality. In turn this caused a huge sell off, with many retail investors panic selling.
The above paragraph could be one written in the future about big tech. Although it is getting ahead of oneself to predict the crash of a sector, it pays to run through scenarios through your head. After such outstanding performance and the size of the big tech companies is becoming a concern, threats to their profits are emerging.
Growth at all costs
With value companies being out of favor, only growth focused stocks have been performing strongly. As a result investors have crowded into the same technology focused growth stocks. This makes thematic investing the order of the day, and makes a contrarian investor's job harder.
As a result, someone who wants to be a first mover is not looking to rotate out of a strongly performing sector into an under-performing one, but is trying to identify the next sector which will perform strongly.
Politics influences investment
A presidential election can throw up a change in policy. Unlike President Trump who is firmly against environmental policies, if Joe Biden was to be elected to be president of the United States, he has set out plans to increase spending on environmental programs. Apart from the 'headline support' this provides, it can also have financial benefits to investors. This could mean tax breaks for companies in the designated sector, in turn increasing their profits to your benefit.
A sector within a sector
Although it is hard to find undervalued stocks in this current market rally, it may be possible to find niches which still have value to them. Artificial intelligence and video games are areas which are increasingly attracting investors' attentions.
Although by no means cheap, why not reduce your holdings of the Amazons and Googles of this world. You can re-invest the proceeds into the video game and artificial intelligence sectors? Video games in particular are not an area that 50-something-year-old portfolio managers may be personally familiar with.
Your youth may be an advantage.
Since the older generation is the one which controls the majority of the world's assets, it may not have cottoned on to younger members of society being prepared to pay to watch others play video games!
How to rotate your portfolio
It takes a brave soul to sell out of one sector straight into another. So why not do it in stages? If you have investments which have increased by or near 50%, why not take some profits? With the proceeds you can start investing into or adding to a new sector which may have greater future growth.
Go off the beaten track?
The rise of videos showing how to do-it-yourself has meant other newer or 'old person' asset classes are coming to the fore. Although cryptocurrency trading is firmly a momentum investing play, others are not. Asset classes such as art investing, coin collecting and stamp collecting were seen as something your grand-father did. Today they are drawing in a younger age-group.
Conclusion
No investor ever truly buys at the bottom and sells out at the top. Taking a disciplined and organised approach, where you have a clear strategy ensures that you can rotate out of one sector and into another without regret.
Accepting that you may lose 10% by reducing or selling out of a sector ahead of other investors, will be worth it when your new chosen sector outperforms. When the mainstream press starts talking about a hot new sector, this is a good time to move into another. A successful investor is never afraid of trying something new and getting in first.