Sector Rotation Strategies

ETF sector rotation strategies: what works and what doesn't?

The major reason why I started this website was to determine if ETF sector rotation strategies work. So what works and what doesn't?

High Success Rotation Strategies

Low Success Rotation Strategies

The first strategy I tried was to determine each month's best performing sector, then rotate into it the following month. This turned the starting $1000 into $1492.39. So this strategy did beat the S&P500 by 5.86% over the timeframe I tried it for. However, this outperformance would almost certainly be significantly reduced once dealing charges and buy/sell spreads are taken into account.

I then tried a similar strategy of determining the worst performing sector each month, then rotating into it the following month. I thought buy low sell high might work. In fact it was a disastrous strategy, turning $1000 into $721.83 - a 27.8% loss.

Despite the failure, this was a very interesting experiment. It appears that on shorter timeframes, buying high and selling higher works much better than buying the losers and hoping for a turnaround.

But You Can't Time Markets...

Two phrases frequently appear when you talk to people about stock market trading:

  1. You can't time markets.
  2. You can't outperform the S&P 500.

I'll get onto the second on later. But as to not outperforming the S&P 500, this is absolutely false. You CAN outperform the market itself.

My calculations show that if you had bought $1000 worth of the S&P500 in January 2021 it would have grown to $1409.81 in mid-October 2024. So that's a return of 40.98%.

However, if you had only invested in the best performing of the 11 US market sectors during each month, over the same timescale the $1000 would have grown to an incredible $36,747.42 - a 3674.74% return!

So what's the catch?

The problem is that you would have needed a crystal ball to have determined which sector was going to be the best performer in each particular month. So while such an outsized return is theoretically possible, in practice it is extremely difficult to outperform the S&P500 to this level.

Two strategies that can apparently outperform the market itself are buying ETFs at 52 week lows and buying the dogs.

As for timing the markets, this is possible using Simple Moving Averages. These can be extremely effective at predicting huge declines, such as what happened in 1987, 2008 and 2020.

Another way of avoiding huge crashes is to check for the number of stocks making new highs compared to new lows. This is the basis for the ETF Sector Data Fear Index gauge you can see on this site's home page. It's currently reading 0%, which is a sure sign that investors are currently extremely complacent.