Catching Sector Rotations

by: Roger Nusbaum

Roger Nusbaum submits: As I often write about sector picker's markets (as opposed to 'stock picker's market' which I find to be a very empty concept), it should be easy to see what sectors tend to do well if 'flat or down' turns out to be right.

For some reason rattling off the usual defensive-ish sectors does not feel like the right way to go. A prime example would be the utility sector. In 2005 utilities outperformed the S+P 500 by a wide margin. The sector rotated into favor, I think, because of perception about a bunch of different things about the market, the economy and political reasons (still enjoying the lower tax rate on dividends). I don't think there was something new or some gotta-have-it aspect of the business or an obvious demographic theme that made the sector do so well. Based on that, I don't expect utilities to lead. Staying anywhere close to the market and paying a nice yield in 2006 would be just fine with me.

I have written about this before as it applied to certain emerging markets. Thailand was a world leader in 2004 and a laggard in 2005. The market does not perceive Thailand as having something to sell that the rest of the world needs. Thailand is expected to grow GDP by 4.7% in 2006 but there are some political issues there that make a good market a pick 'em

As I think about some other sectors like tech, financials and telecom I have to wonder whether money won't rotate into these sectors. In 2005 , tech and financials finished even with the S+P 500 and telecom lagged (in mid-December I wrote about my belief that telecom has a good shot of outperforming in 2006). In 2004 tech lagged badly and financials slightly outperformed but telecom lead. In 2003 telecom lagged badly tech beat by a lot and financials did very little.

After being in the middle of the pack for so long it is right to wonder whether financials will lead. They are not defensive, but it has been so long since the sector did something big, why not in 2006? Another contrarian nugget going for financials is that this is exactly the time (because of the yield curve slope) that financials should lag.

Tech is off to the kind of start that should make anyone wonder if it is back. I don't see that tech should be back (fundamentally) but it has done well and I am capturing it for clients. Tech is obviously not defensive, but could do well I suppose.

Keep in mind that I am brainstorming with this. Also, if tech and financials do well, my 'down a little' prediction will be wrong. Both sectors have such large weights that the market would be hard-pressed to do poorly with tech and financials doing well.

What about large cap? So many people think large cap will finally do well. A contrarian might think that small cap might just continue its long run of success.

And I am still very optimistic about emerging markets -- which is not a defensive play either. The stories in India and China are still unfolding and I believe the resources story will continue to help certain countries.

I guess the shorter answer might have been that this has been a weird cyclical bull market and some rules of thumb have not worked as normal.

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