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Sector Rotation Strategies

The goal of sector rotation is to increase exposure to the best performing sectors and reduce exposure to the worst performing ones. Momentum strategies are designed to react to changes in the overall market outlook and modify sector exposure accordingly. If done properly, the distinct advantage of this strategy versus the “buy-and-hold” strategy is the ability to capitalize on specific market fluctuations—possibly benefiting from industry upswings and avoiding downturns.

Below are some common sector rotation strategies:

Technical analysis – Examining the price changes of other securities and indices is the basis for buying and/or selling. The investor looks for relative strength, which is the comparison of a security’s price movement in relation to its competitors, the industry or the overall market. Pinpointing impending rotation can be done using broken trend lines or major moving averages. The key is watching for signals that a trend in relative strength, either upward or downward, is breaking— which necessitates a change in holdings.

Top-down analysis – Believing that changes in the broad economy have significant, yet different, effects on individual industries determines sector movement. By following economic cycles, an investor chooses specific industries that may have strength in the given or forecasted climate. This typically causes movement from one industry to another sequentially, due to anticipation of the various stages of economic expansion and contraction.

Fundamental analysis – Evaluating the financial statements of companies within the sector may allow the investor to determine possible company-specific strength. The goal is to rotate between sectors that continue to grow at high, but consistent levels, and at a P/E discount to their growth.

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