What Sector Rotation Is — the Business Cycle and Leadership Shifts
As the economy cycles through recovery, expansion, peak, and recession, the sectors leading
the market change. We explain the sector-rotation principle, which sector
leads at each stage, and how to catch the rotation with Relative Strength (RS).
💡 Key takeaway — Investing in the sector that fits the current stage of the business cycle can earn excess return (alpha) versus the market. The key is reading the shift in which sector leads.
What Is Sector Rotation?
Sector Rotation is the phenomenon where capital moves into a particular sector at each stage
of the business cycle, shifting which sector leads the market.
Institutional investors forecast the business-cycle stage and shift positions ahead of time.
A retail investor who reads this flow can also increase their profit opportunities.
The 4 Stages of the Business Cycle and the Leading Sector
Recovery — rates bottom out, corporate earnings begin recovering. Leading sectors: Financials, Materials, Industrials. Cyclical stocks lead.
Expansion — economic growth accelerates, consumption rises. Leading sectors: IT, Consumer Discretionary, Energy. Growth stocks are strong.
Peak — inflation rises, rates get hiked. Leading sectors: Energy, Materials, Real Estate. Hard assets act as a hedge.
Recession — the economy contracts, demand falls. Leading sectors: Healthcare, Consumer Staples, Utilities. Defensive sectors are strong.
Catching the Rotation With Relative Strength (RS)
Relative Strength (RS) — each sector ETF's (XLK, XLF, XLV, XLE, XLP, etc.) return
compared to the S&P 500 — rising signals that capital is flowing into that sector.
Catching the early stage where RS turns up lets you enter near the start of the rotation.
Using DawnScan's Sector Scan
When stocks from a particular sector cluster heavily on the DawnScan
scanner, you can read that as a rotation signal into that sector.
Also check sector trends and leadership shifts on the daily report.
Pairing it with beta and VIX also lets you manage risk.
Caution — Forecasting the business cycle is very difficult. Sector rotation
is a reference framework, and all information here is for reference only. The investment
decision and its outcome are your own responsibility.
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Frequently Asked Questions
What is sector rotation?
Sector rotation is the phenomenon where capital moves into a particular sector at each stage of the business cycle (recovery, expansion, peak, recession), shifting which sector leads. For example, Financials and Materials tend to be relatively strong during a recovery, while Consumer Staples and Healthcare tend to be relatively strong during a recession.
Which sectors are strong during a recession?
Defensive sectors are relatively strong during a recession. Consumer Staples (food, household goods), Healthcare (pharma, medical devices), and Utilities (electricity, gas) tend to keep steady demand regardless of the economy. They typically carry a low beta and often have stable dividend income too.
How do I check sector rotation?
You check sector rotation by comparing each sector ETF's (XLK, XLF, XLV, XLE, XLP, etc.) Relative Strength (RS: sector return vs. S&P 500 return). A sector where RS is rising is a signal that capital is flowing in. An RRG (Relative Rotation Graph) chart is also useful for visually reading rotation direction.
How does DawnScan read sector strength?
On the DawnScan scanner, you can gauge which sector is currently strong in the market based on the sector of individual stocks. When stocks from a particular sector show up on the scanner in large numbers at once, that's a signal capital is flowing into that sector. You can also check sector trends on the daily report.