Why Sector Rotation Is Not the Best Strategy for Investors
Hot on the heels of the September jobs report, financial sector stocks vaulted out of their week-long malaise and into the spotlight.
One factor potentially driving banks higher is better-than-expected data on unemployment, despite a dip in hiring. That could mean the Federal Reserve would be less inclined to slash interest rates, which, of course, would likely put a dent in bank earnings.
Year-to-date, financials are trailing every sector except health care, energy and materials. However, the investing landscape can and does shift abruptly. Over the past month, financials have outpaced the other Standard & Poor's sectors, as well as the S&P 500 index itself.
[See: 7 Easy Ways to Invest Without Much Money.]
So what's the lesson for investors here? To quickly shift holdings as one sector assumes leadership over others?
That's a lot more difficult than it sounds.
Over the past three and six months, the sleepy utilities sector was the leader. Utilities are considered defensives, as they consistently pay dividends, and earnings are generally stable, despite any downturn in the broader equity market. Businesses and consumers continue to need power, regardless of how the S&P 500 is performing.
As the large-cap index became more volatile during the spring and summer months, investors piled into the stability traditionally offered by financials.
But on a year-to-date basis, the picture is different. Here, tech stocks are the shining stars, with real estate coming in second, and utilities third. Like utilities, real estate can also offer steady income streams through rent and mortgage payments that flow through to investors.
While the case for reliable income through defensive stocks makes intuitive sense in a volatile market, the rise of the tech sector may seem a bit surprising. That's exactly why attempting to predict what sectors will lead or lag is a difficult endeavor.
As investors consistently hear, it's best to always be broadly diversified, and sector rotation provides an excellent reason for that. A look at the top sectors over the past six months, besides utilities, shows why that's true.
Consumer staples is another example of a defensive sector. The most heavily weighted stock in the S&P consumer staples sector is Procter & Gamble Co. (ticker: PG), whose best-selling brands include Always feminine hygiene products, Ariel laundry detergent (sold outside the U.S.), Bounty paper towels, Charmin toilet paper, Crest toothpaste and Dawn dish detergent.
Do you see a common theme? These are products that people still need, and will continue to buy, regardless of an economic or stock market downturn.
[See: 6 Things to Consider Before Investing in IPOs.]
Here again is an example of a sector finding support during a time of market volatility. However, over the past month, the sector is down 1.02%. Markets are still volatile, but institutional investors sometimes simply favor one sector over another for reasons that may seem murky. The institutional owners may also want to take some profits.
It's tough (really, impossible) to predict sector leadership consistently, and rotation can happen in the blink of an eye.
Despite a name that sounds like it encompasses a wide swath of the economy, including residences, the top holdings in the S&P real estate sector are a diverse group of real estate investment trusts, or REITs.
For example, American Tower Corp. ( AMT), which comprises 12.5% of the sector, owns wireless and broadcast towers, and other electronic relay towers. In other words, it owns those collections of sophisticated electronic and communication devices that you see along highways, near buildings or along mountain ridges. The company leases space on those towers, putting it in the REIT category of investment.
Other heavily weighted REITs in the sector include Crown Castle International ( CCI), another company that leases space on communications towers, and ProLogis ( PLD), which is in the business of logistics real estate. In plain English, that means it owns and rents out facilities central to the logistics of moving goods around the world. That could mean warehouses, distribution centers or other types of industrial properties.
Although the real estate sector is up 7.81% on a six-month basis, it's down 1.38% over the past month.
What's the next big thing? That's anybody's guess. It's certainly true that some sectors remain in the doldrums for extended periods of time, but that changes. Not may change. It does change.
For example, on a one-year basis, the tech sector, home to companies that traditionally sport fast growth, has actually been something of a laggard, despite a positive return. It's notched a one-year gain of 4.36%, which places it behind real estate, utilities and consumer staples.
But over the past five years, it's been the clear leader, doubling in value.
[See: 11 Steps to Make a Million With Your 401k.]
The upshot here? Remaining invested across various sectors has been steadily rewarding in some cases, but more vexing in others. Unfortunately for those who view sector rotation as an investment strategy rather than simply a consistent set of changes in asset class performance, sector leadership is not always easy to predict.
More From US News & World Report
