Sector Rotation Redeemed?

By Chip Anderson  of The Chart watchers Newsletter 20 July 2003

It's been quite some time since we looked at the Sector Rotation charts on , so I was quite surprised to see the almost textbook alignment of things that's now on our Sector SPDR PerfChart.

Remember, this chart shows the performance of the nine major S&P Select Sector SPDRs (tradable ETFs) relative to the S&P 500 index for the past 65 trading days. For example, from this chart you can see that the Technology SPDR has outperformed the S&P 500 index by 4.9% from 16 April thru last Friday, while the Energy SPRD has underperformed by 4.2%.

Now, connect the tops of each histogram bar on that chart together with an imaginary line. See the nice sine-wave pattern that makes? Now compare it with the chart to the right:

This theoretical model is based on Sam Stovall's S&P's Guide to Sector Rotation and states that different sectors are stronger at different points in the economic cycle. The graph above shows these relationships and the order in which the various sectors should get a boost from the economy. The Market Cycle preceeds the Economic Cycle because investors try to anticipate economic effects. The PerfChart at the top of this page tries to help you see this effect. The blue box on this chart is our best guess at where things stand right now based on the PerfChart.

This chart shows a simplified version of Sam Stovall’s theory of Sector Rotation. It shows how different sectors get stronger then weaker as economy moves in cycles. It also show how the stock market tries to anticipate this effect prior to it actually occurring. So, for instance, when the economy (the green wave) is just starting to recover, the stock market (the red wave) is already well above it's previous lows in anticipation of the recovery. Using this effect, Stovall shows how - all other things being equal - Technology and Cyclicals (Consumer stocks) - tend to out perform just after the market bottoms while Energy and Consumer Staples tend to out perform near long-term market tops.

While it sounds great in theory, the sector rotation model is hard to use as a timing tool since shorter-term price noise in the market that can cloud things. Still, we maintain our Sector SPDR PerfChart so that anyone can monitor this effect. Having watched it closely for over 4 years now, I have never seen such a nice correlation between reality and theory as I see in the chart above. While it may just be a coincidence and bears close watching, it helps me feel better about where I think the market and the economy really are right now - entering a new upswing - and gives me a more bullish bent on longer term chart analysis.


 

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