2023 Mid-Year Outlook: What's your next eyeing sector?
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Which Sector Will the Rotation Turn to Next?
Tech has been killing it in the market this year, thanks to the artificial intelligence boom. The tech sector has lifted the entire market while other sectors have greatly underperformed.
Occasionally, an overheated sector will begin to cool off as investors rotate their capital into underperforming sectors in expectation of a broadening rally or a change in the economy.
Even the NASDAQ announced a special rebalancing later this month, which will reallocate the weighting of the stocks within the index. Will the current market rally broaden out to other sectors besides tech?
To catch a potential rotation before it happens, you could follow the economic cycle, which has proven to be a profitable investment model year after year. Many call this business cycle or economic cycle investing.
Some economic cycles happen at a faster or slower pace. There are also mini economic cycles within larger super economic cycles, so timing your rotation of capital can be tricky.
It is especially tricky to time when analysts across the board have been calling for a recession while the major indices are in a full rally.
Where Are We in the Current Economic Cycle?
The stock market typically front runs the economic cycles as investors try to get on board early to catch the bottom or top of the market. You can see an illustration of this in the chart below. The chart also indicates which sectors investors should rotate their capital into during each step of the economic cycle. Although this chart is not perfectly realistic, it does provide a general roadmap to follow.
So where are we in the current economic cycle? If you simply follow the equity markets performance, disregarding economic data, then currently we are experiencing the beginning of a bull market. I've highlighted this area in the chart below by a yellow circle.
If you follow the economic data, then you might think we are in a slight contractionary environment, which is on the other side of the chart. This can be arguable.
Personally, I just follow the stock market trends even if they contradict economic conditions. This way, I dont miss out on potential gains.
So where will the capital rotate into next? In the chart below you can see the 11 S&P sector indices, as well as an all sector equal weighted index. These sectors have performed according to economic cycle investing almost perfectly.
The only anomoly would be the banking scare that has kept the financial sector from recovering properly within the cycle.
Below, you can see the performance of each S&P sector over the past 6 months. They are labeled in order from top performer to worst performer.
The AI boom lifted tech over all other sectors. After tech, wages and employment numbers propped up the consumer sectors. Government spending allowed the industrials and materials sectors to somewhat improve. Meanwhile, defensives like healthcare and real estate lagged the rest of the market along with energy.
Any way you look at it, the market appears to be abiding to the economic cycle investment strategy.
Where will the capital rotate?
Tech, industrials, and consumer sectors have been greatly outperforming. If you are following the economic cycle, then currently, we are in the beginning of the cycle based on sector performance. These sectors could continue to outperform, so dont jump out of a rally too soon. But the next areas to gain some ground should be the materials, staples, defensives, finance, energy, and utilities. Roughly in that order.
Personally, I just follow the technical trends and wait for a weak sector to start gaining strength before I move my money into another sector.
Where to Put Your Money
I think this tech rally has more legs, but the rally is very overheated and needs some selling to cool off. When this cooling off happens then I think investors will move their capital. So, I will be watching some large cap companies in some underperforming sectors that have historically outperformed the market.
I focus on companies that exhibit a long-term technical uptrend. These companies are in the major indices. Or these companies are heavily institutionally invested as you see them in a majority of the profitable ETFs.
I am also watching crypto related equities, EV stocks, a few commodities like uranium and lithium, chinese equities, treasuries, and ETFs that track a few other countries' markets besides the US.
But whatever I am watching, I will not jump in early. I like to wait for a technical uptrend to develop on the charts before I allocate any capital.
As always, this is not investment advice. Good luck trading. Be careful and be patient. Give your investments time. Don't be greedy. Don't invest in anything you don't understand. Don't put all of your eggs in one basket. Don't listen to the hype. Don't fomo or panic into or out of trades. And just follow the trends. A trend is your friend.
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