Carburton Street, London – What is stock rotation? Does it really exist? Or is it simply the figment of the imagination of market news reporters? Stock rotation is said to occur when traders and investors move their money from one sector of the market to another. Stocks can even be rotated from one country to another. And rotation in the most extreme can happen when investors shift their money out of the market completely and into cash or bonds.
But how do we know that rotation has taken place? Regular readers of market news reports will realise that stocks rarely move in isolation but tend to either rise or fall in whole groups. So on a particular trading day or week, you might find that an entire collection of bank stocks would rise prompted by newsflow relating to the sector. Perhaps interest rates are expected to rise shortly or an analyst believes that bad debts for the banks might be worse than expected. On another occasion a whole bunch of oil stocks may go on the decline if oil prices are affected by events within the industry.
There is no point denying that stock rotation can, and does, occur. Rotation might happen for a variety of reasons. Investors in the market might feel that the expectations for a particular industry might be starting to look more promising and that valuations have not exactly reflected this brighter outlook. Alternatively, investors may feel that because of undue pessimism within a sector the stocks have been unfairly undervalued. This could prompt a sell off of overvalued stocks in order to release the necessary funds to invest in the undervalued sector. There might be situations when investors could be deterred from investing in some sectors of the market because of unquantifiable risks and might prefer to invest their money in safer issues, the so-called defensive stocks.
But investors, who try and second-guess when particular sectors are likely to fall in or out of favour, and attempt to time their investments accordingly, are almost on a hiding to nothing. Switching from one sector to another can be a costly exercise and there is little evidence to suggest that it is possible to predict which sector is likely to be the next one to gain favour from the market. And switching out of one sector could leave the investor less well off should stocks in that sector continue to rise. However, those who feel they have the wherewithal to play the sector rotation game should pay close attention to brokerage and trading costs. This is because regular trading can soon diminish any gains that might otherwise be made.
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