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Sector rotation is another possible ETF strategy which involves some active management, but also plays into
a long-term investment approach. The basic idea behind sectorrotation is that the economy operates according to
cycles and some sectors will
be up at certain times and down at others. Investors using this approach must identify
the boom and bust cycles in the sector they plan to invest in. Then, during the down periods, buy and then turn around
and sell when the prices are at their peakright as the boom is ending.
To use a sector ETF rotation strategy, an investor must first decide on the asset allocation for their portfolio.
A more diversified investment approach is always safest, so the investor will want to decide what proportion
of the portfolio should be devoted to sector rotation and how to invest the remaining portion.
Some investors will choose to make ETFs a separate asset class in their portfolio.
Other investors may fall in love with ETFs and may want to make them the cornerstone of their portfolio.
However, even if you want to keep ETFs as the core of your financial strategy, it is a good idea to split the risks
between broad market ETFs and sector ETFs. That way, even if the entire sector goes against your
predictions, the losses should be absorbed by your market ETFs.
After determining what percentage of your portfolio to devote to the sector rotation strategy, the next step would
be to identify the business cycle that you want to target (it can be a business or calendar cycle - the key is simply
to identify it). Once the cycle is identified, the investor then needs to determine which companiesbenefit
from it. Many companies have predictable cycles that are based around the holiday season and will have their
peak business during this short window. Retailers certainly fall into this category and an investor may want
to shop around
for ETFs in this sector around mid-summer (before the back-to-school rush begins).
Peak profits will probably come from selling the ETF during the first week of January.
Ideally, an investor would have already identified a sector that benefits from the post-holiday boom and be
invested in that too. At this point, it would be good to be identifying sectors that would normally benefit from
the summer season (travel-related businesses like airlines, hotels, etc.) and be purchasing ETFs now for that period
while prices are low. Sector rotating involves always looking ahead to the next cycle while being fully invested in
the current one.
During the current cycle, however, the key is to keep rotating in the ETFs relevant to the identified sector.
By doing so, an investor should be able to outperform any single sector ETF.
This kind of ETF sector rotating strategy involves some research in the beginning, but is fairly hands-off
once everything is set up. The ETFs will be rotated in and out at predetermined points chosen by the investor.
However, there are other ETF sector rotation strategies for investors to consider. The Stovall Rotation Strategy
is a more involved approach that forces the investor to make far more decisions.
The Stovall Rotation Strategy divides the economy into basic sectors: Technology, Basic Industry, Industrials,
Cyclicals, Energy, Utilities, Staples, Services, and Finance. The
strategy also assumes that each sector is always
in one of four stages: early recovery, full recovery, early recession, or full recession.
The basic sectors do not all have to be in the same stage at the same time which is where the potential for
profits comes in - if investors can predict which sector is about to take off and when the others ones are cooling
down - the investor will be able to make money .
The key for investors using the Stovall Rotation Strategy is to always be buying into a sector that is about to
take off and selling at the peak to reinvest into the next sector. By remaining fully invested in inexpensive
ETFs, an investor is always poised to take advantage of up trends while being diversified enough across
the sector to be reasonably secure against heavy losses.
Plus, with so many sectors to choose from, an investor does not have to necessarily have to invest in an area
they are uncomfortable with.
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