● In the context of developing countries, sector rotation refers to the cyclical boom and bust of different sectors in the stock market due to the movement of capital.
● In the capital market of developed countries, sector rotation often synchronizes with an economic cycle, with different asset classes delivering varying performance.
● Investors can anticipate sectors that tend to outperform the others based on the sector rotation theory.
Sectors move in and out of favor of investors in different stages of an economic cycle as investors move their money into an industry they predict will perform better than the others.
This process is known as sector rotation.
What happens in sector rotation
Typically, sector rotation of a shorter cycle appears in emerging markets.
There tend to be fewer hotspots due to their limited capital size. Investors generally favor one or a few particular sectors before moving into several others, causing different sectors to go up and down over time.
Sometimes, there's even a stunning divergence between heavyweight and small-cap stocks.
Sector rotation of a longer cycle describes the varying performance of asset classes in different stages of an economic cycle.
For example, investors typically favor commodities (i.e., non-ferrous metals, coal, and oil) and consumer discretionaries sector during an economic boom.
When the economy transitions from growth to recession, investors tend to get defensive, turning to bonds, cash, and healthcare and utilities sectors, while commodities usually fall out of favor.
Sector rotation is part of the market dynamics.
Investors can identify critical changes and take advantage of the cycle by closely watching policy shifts, market developments, and popular investment themes.