Macro
Advanced5 Min Read
What Is Sector Rotation?
Money changing sectors without leaving the market — and how that tracks the economic cycle.
Some days the index closes flat while something large happens underneath: banks up 3%, technology down 3%. No money left the market; it moved. That is sector rotation, and it is where the macro articles connect to a portfolio.
Two Families: Cyclical and Defensive
The whole of rotation rests on one distinction.
Cyclical sectors breathe with the economy. When people feel good they buy cars, take holidays, renovate. Banks earn from loan growth and the rate spread. These sectors outrun the index in expansions and fall harder in slowdowns: industrials, consumer discretionary, financials, energy, materials.
Defensive sectors are less affected by the cycle. Electricity bills get paid in a recession too, medicines are bought, detergent runs out. They beat the index in slowdowns and lag it in booms: consumer staples, healthcare, utilities, telecom.
Why Rates Dominate
The last line of that example is the important one. A company is worth its future cash discounted to today. The discount rate is the interest rate.
A company whose profits arrive soon (a mature bank, a grocery chain) is barely affected by rate changes. A company whose profits are expected far out (a growth name not yet profitable) is affected enormously — distant cash discounted at a high rate is worth far less.
That is why rotation becomes almost mechanical when rate expectations shift. Every signal in the yield curve and hawkish/dovish articles shows up here first.
Four Phases of the Cycle
The classic model is this — a frame, not a rule:
| Phase | Economy | Leadership |
|---|---|---|
| Early recovery | Turning up off the bottom, rates low | Financials, consumer discretionary |
| Expansion | Fast growth, rates rising | Technology, industrials |
| Peak / slowdown | High inflation, rates at their top | Energy, materials |
| Contraction | Slowing, rates start coming down | Staples, healthcare, utilities |
Seeing Rotation
The most practical sign of rotation is market breadth: when the index rises, how many stocks are up? If the index gains 1% while only 35% of its members are green, the rise is coming from a few large names and money is flowing elsewhere underneath.
The second sign is sectors not moving together. In a panic everything falls at once (correlations go to 1); in a healthy rotation some rise while others fall.
Where You'll See It Here
Three screens read this subject directly: