I've been doing research on sector rotation recently, most of you who have researched the subject are probably familiar with this image or one much like it
I have been thinking a lot about this chart over the last couple of days.
To my mind it seems apparent that if you are a long only investor who likes to follow the market trend then sectors like Industrials, Materials, Energy will perform the best against a timed market.
e.g. if you tried the same long only strategies with Healthcare or Finance you would be going against the larger stock market trend and while returns may outperform the index for such sectors at that point in the cycle they might not be profitable. Therefore positions in sectors which go against the market trend might require hedging against the market (e.g. long Financials short XJO) to return a profit and this is out of the scope of a long only investor.
So traders who follow the "market trend" when its up to buy spec stocks should be focusing in the sectors associated with a bull market rather than all sectors, and hopefully scans should confirm the rotation into and out of each sector to give extra confidence in the model.
I also note, that the energy sector sits at the top of the stock market cycle, so when energy stocks are outperforming the index and then stop outperforming that is indicative a cyclical market top is being put in place. This seems confirmed when looking at the XLE/SPY or XEJ/XJO for 2011.
What do you guys think?