Sector Rotation Across the Business Cycle

Abstract

Conventional market wisdom posits that sector rotation over various stages of the business cycle generates market outperformance. We introduce a simple way to test the value of sector rotation. In our test, an investor anticipates business cycle stages perfectly and rotates sectors in accordance with conventional practice. Even with perfect foresight and ignoring transactions costs, sector rotation generates, at best, a 2.3 percent annual outperformance from 1948 to 2007. In a more realistic setting, outperformance quickly dissipates. We do find an alternative rotation strategy that historically beats the market by 7 percent. Whether by chance or due to fundamentals time will tell.

Keywords: stock market, sector rotation, business cycles, investment strategies

JEL Classification: E32, G10, G12