A more anecdotal method involves taking a look at the performance of different sectors and asset classes over a given period to determine where in the investment cycle we are. Based on the intermarket relationships we talked about earlier, a bond rally turning south coupled with increased buying in stocks could mean that equities are about to start a more sizable run. Within stocks, comparing sectors that are historical leaders or laggards can point investors in the right direction as to which sector to be heavy on and which to avoid. When a leading industry such as transportation starts to see an uptick, it may be a good indicator that it's time to take a position in later-stage industries such as consumer staples. (Martin Pring’s book Technical Analysis Explained provides an excellent table of industries grouped by their leading or lagging effects during cycles.)
For more sophisticated investors, there are a number of proprietary models that are designed to determine what stage of the investment cycle we're in -- and to help allocate a portfolio accordingly. Generally speaking, though, these models are either incredibly expensive to license or incredibly complex to implement. As such, they’re generally relegated to professionals. For most technicians, the first two methods offer a much more accessible way to employ asset class rotation, often with better results.
Recently, the introduction of the Relative Rotation Graph, or RRG, in 2011 by Julius de Kempenaer has added a distinctly visual element to analyzing relationships and rotations between asset classes. RRG charts are now available free via StockCharts.com.
This Relative Rotation Graph of S&P 500 sectors shows their clockwise rotation from lagging to leading. In the chart below, consumer discretionary stocks are distinct leaders, while utilities are lagging the worst.
While “sector rotation” is a common phrase on and off Wall Street, implementing it effectively requires a bit of uncommon knowledge. Now you should be set to allocate your portfolio in line with sectors or asset classes exhibiting strength -- and be aware of which are likely to be next in line for a move higher.
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