• Trading 101: Aligning Sector Rotation with the Business Cycle

    by  • August 6, 2013 6:00 am • Trading 101 with Peter Bryans • 0 Comments

    As this bull market has matured, we have seen different inter-market relationships work their course. Since about 2000, the correlation between stocks and bonds has been negative—as bonds have rallied, stocks have declined and while stocks have rallied, yields have climbed. With the ten-year note yielding nearly 2.65 percent, bonds have been selling off as the market has matured. This inverse correlation between the two asset classes clearly has been in play.

    Below, I have a graphic that illustrates the stages of the business cycle and how the asset classes all interact with one another in times of either expansion or contraction. Whether or not you believe that the economy is recovering (not a topic I’m going to cover on here) the relationship between stocks/bonds/commodities could arguably be in the 3rd or 4th cycle. Unemployment levels have come down, and just this past Friday (8/2) we added 160,000 jobs as the unemployment rate ticked down to 7.4% from 7.6%.

    (courtesy of StockCharts.com)

    If we are going to see stocks continue to rise, and also see this bull market mature over time, then gradual sector rotation is likely to take place. Set forth below, are the sector summary returns for the past year (featured first) and the past six months (featured second).

     (courtesy of StockCharts.com)

      (courtesy of StockCharts.com)

    Financials near the top is a strong sign for the market, and they were the top performing sector in 2012. As rates rise, and the yield curve steepens (the spread between long and short-term rates widens) banks will continue to perform well. Notice how Energy and Materials—on both a one year and six month basis—have been under performing the other sectors. This graph below does a good job showing how sectors will lead/lag over time.

    (courtesy of StockCharts.com)

    Look at this last graphic that shows sector returns near the top of the bull market from 2007. This shows the returns for the various sectors in the Summer of 2007, right before the last cyclical bull market ended—the market did not hit its peak until October of that year. Materials and Energy were the strongest performing sectors. It appears that we are a long way from the final stages in the business cycle.

    (courtesy of StockCharts.com)

    Some final thoughts on the market and what we are seeing with the various sectors: First and foremost, this is clearly a much longer-term picture of the market and what we could see over the next few months, quarters, or even years. Second of all, there are certainly no guarantees that the market will continue to climb. I honestly have no idea how much longer this bull run will last—but I do know that I will keep a close eye on different sectors, and see if a rotation is starting to take place. As a trader, our job is to find the strongest/weakest spots in the market and exploit them. Having a basic understanding of the business cycle and how this aligns with the various sectors is an absolute must.

    About

    Peter Bryans joined the Schaeffer's Investment Research trading team as a Trader in April, 2012. A graduate of the Fisher College of Business at The Ohio State University -- where he concentrated in Finance -- Peter previously held internships with an insurance broker and a wealth-management firm. In his current role, Peter trades a variety of our real-time option services and also hosts our "Options Apprentice" weekly webinar presentations.

    http://www.schaeffersresearch.com

    Leave a Reply