‘Sector rotation’ is a term that often crops up in the financial pages towards the beginning of the year when, for no better reason than it is the start of the year, money managers are inclined to consider what they might do differently from the previous 12 months. The term is used as a catch-all for the idea that asset managers sometimes shift their money in concert from one area of the stock market to another.
Another reason why you may have recently spotted the phrase, however, is that the end of 2012 and January have seen a strong rally in certain, more economically sensitive, sectors of the market. This has sparked talk not just of a potential ‘rotation’ from fixed income to equities but also from more defensive equities into the more cyclical sectors ones that have done better this year so far.
As value investors, the idea that these sorts of shifts in the market would drive investment behaviour is something we find odd. Investors who go out to try to and explicitly benefit from sector rotation are implicitly taking a view on who owns all these different shares and what these people may or may not want to own tomorrow or next week or whatever. This comes down to guesswork and following what is already happening – quite literally following the herd. This is always a risky thing to do in our view.
Still, here on The Value Perspective, we don’t have to worry about trying to forecast future sector rotation because, as value investors, we are inevitably drawn to sectors and companies that have been out of favour and that the market has not wanted to own as much as others. When those businesses ‘rotate’ back into favour and people are willing to pay higher prices for them, value investors often do well. Value investors do not have to make a conscious effort to target sector rotation per se, but they often still benefit from it when it happens.
One final thing to take from this is the importance of understanding the real reason something happens. Ice cream sales pick up in the summer not because it is the summer but because it is hot. Similarly, sector rotation does not happen because it is a particular time of year but because the broader market is noticing the cheapness in sectors that, all being well, value investors should have already identified.