Glossary
Sector rotation
Money shifting from one market sector to another as the economy or interest rates change, and strategies that try to follow those shifts.
On this page
Sector rotation describes investors moving money out of some parts of the stock market and into others, often in response to changes in economic growth, inflation or interest rates. The term also names a strategy: deliberately overweighting the sectors expected to do best in the next phase of the economy. Watching rotation helps explain why an index can sit flat while many of the stocks inside it are moving sharply.
How it works
The classic model ties sector leadership to the Business cycle:
| Phase | Sectors that have often led |
|---|---|
| Early recovery | Financials, consumer discretionary, real estate |
| Mid-cycle | Information technology, industrials |
| Late cycle | Energy, materials |
| Contraction | Consumer staples, utilities, health care |
The logic is that economically sensitive businesses benefit first from falling rates and rising demand, while defensive sectors with steady earnings hold up best when growth slows. Real cycles are messier than the table, and a given rotation can have causes outside the cycle, such as a surge in oil prices or a technology boom.
What to watch for
- Timing is hard. Economic phases are identified with a lag; the NBER often dates recessions months after they start. By the time the phase is clear, markets have usually priced it in.
- Costs and taxes. Frequent switching between sectors raises trading costs and, in taxable accounts, realized gains.
- Crowding. Popular rotation trades can reverse quickly when many investors chase the same move.
Rotation also happens across styles, such as growth to value or large caps to small caps, driven by similar forces.