I am trying to learn about sector rotation. I think I understand how to do the first few steps (1) figure out what part of the business and stock cycles are currently happening (2) identify what sectors traditionally do well/bad in those parts of the cycle.
What I am having trouble with is the next step Identifying strongest/weakest companies in the sector.
I thought I could determine this with by looking at “market share” but I can’t find that information. I don’t even know how to narrow the field down to a few companies. What factors do I use to find the strongest/weakest companies in the sector ?
Willis, There is a industry/sector charting done within a website called Investools (http://www.investools.com/). They do advocate using their tools for stock picking, however I am not as much of a fan of that. That being said, they do a fantastic job of trending industries against all market caps if that is what you are looking for.
Hello Willis, I cannot agree more with the previous poster. In an efficient market (and our markets are very efficient)- ALL data - ALL known and imagined information and outcomes - and the probabilities thereof - are very, very quickly priced into the market. A good example right now would be Apple. Apple stock is currently trading at $619 per share. Do YOU (or I, for that matter) know something about Apple that the thousands of analysts who follow apple - and the hundreds of thousands of individual investors, mutual funds, institituions, hedge funds, and day traders DONT know? Can you (or I) say with reasonable certainty that based upon OUR analysis of the exact same information that every other analyst and investor in the entire world has - that WE and WE ALONE can identify that Apple is currently mispriced in the market and should be worth more (or less than) how the market has currently priced it? Have you or I thought of a possible outcome for Apple that no one else has thought of? Doubtful. That is why the Nasdaq 100 ETF (ticker QQQ) is made up of about 16% Apple Stock - the market has already overweighted this stock's value within the market itself - and will continue to overweight (or underweight) it as new, and previously unknowable and unimaginable information is revealed over time.
Given that virtually every analysis method is absorbed into the market rapidly... consistently identifying companies that will outperform is very difficult. Can it be done? Oh, yes - absolutely it can be done and it has been done many thousands of times over. However - very few individuals can do it consistently, and efficiently, over a long period of time. Those that do usually are the ones that have dedicated their lives to it; it is their profession, passion, and hallmark.
So - if you are pursuing a different career; I would suggest that you maybe DO pick a few high conviction stocks here and there using an analysis method you are comfortable with (such as the Dividend Discount Model; you can google it and find it in Wikipedia) in a small, separate account just to scratch that itch - but the VAST majority of your retirement and life savings be done using a far more reliable and proven method such as strategic asset allocation with perhaps a tactical sector rotation overlay for a small (like 10-20%) portion of your portfolio.
I do think that you are right on the mark with being able to identify which sectors are likely to outperform or underperform during certain elements of the business cycle. While certainly not a perfect science - most of these sectors and asset classes to behave reasonably predictibly. So - in that case - overweighting or underweighting your portfolio at certain times in the cycle - or based upon news - may not be a bad idea, as long as it is done sparingly (probably not more than a couple of times per year since the economy doesn't really move that quickly).
But again - the real likelihood of you generating "excess Alpha" (market outperformance WITHOUT incurring additional risk) above and beyond what can be done professionally is virtually nil. And unless you are willing to dedicate literally hundreds of hours of study, and spend a good bit of money on professional analysis tools - the odds of you underperforming, over the long term - a simple, low cost asset allocation strategy using index fund or ETF's is virtually guaranteed.
Hi Willis, I am going to answer your question before providing the requisite cautionary advice about the strategy you are pursuing. To identify sector leaders, I would look at the composition of the SPDR sector ETFs, which pull companies from the S&P 500 index based on sector and weight them by market cap. XLF, for example, is the Financials ETF. Using Morningstar or SPDR's own website, you can easily see the top components of the ETF. In the case of XLF they include Wells Fargo and JPMorgan Chase. The ability to identify the strongest or weakest companies is part of the caution I would apply. There are relatively few people who can do that on a consistent basis, and their names include Warren Buffett and Peter Lynch, and they all definitely made investing their full time business and had teams of talented people helping them. Assuming you don't fit that mold, and you still want to pursue sector rotation, then let me add the following bit of caution. The strategy you are considering is already being pursued by countless thousands of investors, including some of the largest mutual and hedge funds. That means there are likely no excess profits to be made from doing the same thing. And your likelihood of outperforming them, after fees and transaction costs, is pretty low. Nonetheless, I wish you luck with your investments.