Investor's Guide: Sector RotationSellling Some, Buying Others
February 5, 2008 - You may not know the term "sector rotation". It's used by investors to get a read on the market. It's not hard to understand, just a new phrase for many investors to learn. Here's what it means.
Sector rotation is when investors sell certain industry stocks and buy other industry stocks. What really matters is what they're selling and what they're buying. For example, when investors sell consumer durables and drug stocks and start buying tech stocks, it means they're bullish on the economy. If they're buying financials and housing stocks, they're also taking a positive stand. That's because housing and financials are some of the early beneficiairies of an economic recovery. They're the stocks that earn profits sooner than later as people borrow more money (helping the banks) and buying houses.But it's never that easy in investing. There's no bell that rings and declares "Everybody out of defensive stocks. We're all going into tech or banks or housing." Rather, investors one day sell some of their defensive stocks, and buy some of the more aggressive ones. Then the next day, they may hear negative news on their newly acquired aggressive industries and stop buying them, or if they're trading, sell them. Maybe they buy back defensive stocks or maybe they sit on the sidelines with cash. In either case, they stop buying aggressively for the day and see what happens next. What this boils down to is this: sector rotation isn't clean and easy, definite and done quickly. It's more of a trend than an abrupt change. It takes a while for everyone to agree on a direction for a sector. News can affect the trend or specific stock information on a sector leader can spill over on to all stocks in the sector. It's important to watch for sector rotation. It gives a good indication of what investors are thinking. The best way to follow sector rotation is to watch the volume leader list. That's always reported in the Wall Street Journal or you can find it online at many financial sites. When one sector, such as drugs or financials, is dominating the volume list for several weeks, and the stocks are always going in the same direction, you can bet sector rotation is occurring. If volume is high and the stocks are going up, investors are buying. If the volume is up and the volume leading stocks are heading south, investors are getting out. Bullish sectors are housing, financials, and transportation. When investors are scooping these, they believe the economy will improve. Defensive or bearish sectors would be pharmaceuticals, healthcare, consumer non-durables. When buyers are after these, they're looking for a rough ride in the economy for some time. If you can spot sector rotation early, you can adjust your thinking and maybe your portfolio to take advantage of it.
Ted Allrich
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